Who Moved Markets in 2009?
This commentary presents an update of the market impact
of FOMC communications, including a discussion of the relative impact of
different types of communications and a ranking of the market influence of each
FOMC member. As usual, the Chairman dominated the effect of FOMC members on
markets, but several other members began to carry more weight in shaping market
expectations.
As in previous commentaries, we measure the market impact of different types of
communications by FOMC members and rank their effects on the U.S. Treasury market in 2009.
We believe this commentary is much anticipated every year
by members of the Committee, though one has called us a “force of evil” because
he believed that we encouraged members to compete for market influence and win
the coveted “I Moved Markets” annual award. We think he really meant it! Be
that as it may, here we offer this year’s results and crown the winner.
Market Reaction to Speeches by Individual FOMC’s Members
We first look at how the market responded to speeches
(and interviews) by individual FOMC members. Specifically, we measure the change
in the two-year Treasury yield over a 2-¼-hour window bracketing each speech.
We include only speeches that had at least some content pertaining to monetary
policy or the economic outlook, either in the speech itself or in the
question-and-answer session. For example, we excluded speeches that focused
solely on regulatory issues. Unfortunately, we also had to exclude from this
analysis speeches that were either given at the same time as economic releases
or had windows that conflicted with speeches given by other FOMC members. This
happens only occasionally: When possible, we sometimes adjust the window to
prevent the results from being spoiled by the influence of other events.
When considering the market impact of each speech, we
acknowledge that small variations in Treasury yields may result from the noise
inherent in these markets.[2] Nonetheless, we credit the full movements in yields to the speeches rather than
apportioning part of the effect to noise, on the assumption that noise has a
zero mean.
Figure 1 shows the total
effect of individual FOMC members on the two-year Treasury yield. This is the
sum of the absolute value of the impact (measured as the basis-point change in
the two-year yield during the relevant 2-¼-hour window). Chairman Bernanke had
the most impact on financial markets from this perspective, as the Chairman
almost always does. He moved the two-year Treasury yield more than 40 basis
points. President Plosser was a distant second, followed by Presidents Fisher
and Yellen. This does not include the impact of the Chairman’s semi-annual
monetary policy testimonies, which would further magnify his dominance on
financial market effects.
Market Response Per Speech
The Chairman’s influence on financial markets is at least
in part because he gives speeches more frequently than other FOMC members, as
shown for 2009 in Figure 2.
We therefore also compute the market response per
speech, a better measure of how much influence an FOMC member had on the
markets. Figure 3 shows the ranking by individual FOMC members in 2009.
Although still very influential, Chairman Bernanke now ranks behind Philly Fed
President Plosser. Governors Tarullo and Warsh, as well as Presidents Yellen
and Dudley, also recorded relatively large responses per speech.
We find it interesting that Presidents Plosser and Yellen
have become so influential; they did not have much impact per speech on yields in
2008. One possible reason for their increased sway on financial markets is the
information they provide with respect to the distribution of views on the FOMC.
They occupy hawkish and dovish sides of the spectrum, respectively, making them
good signposts for the range of views on the Committee. President Dudley also
became more influential (relative to 2008). His increased impact perhaps should
have been expected, given that the New York Fed now plays an even more unique
role in the implementation of monetary policy, such as its responsibilities for
TALF auctions and the Fed’s asset purchase programs, not to mention its special
expertise on financial market issues.
We saw in 2008 that Governor Kohn, the Vice Chairman, had
become considerably more influential than in previous years, perhaps reflecting
a greater tendency by market participants to pay attention to those perceived
to be closest to the Chairman. In 2009, however, the effect of Governor Kohn’s
speeches appears to have leveled off considerably, despite his perceived and
likely contribution to shaping the Chairman’s views, at least more so than
other FOMC members.
We had not anticipated
the increased influence of Governors Tarullo and Warsh. The attention on
Governor Tarullo is especially surprising, given that he is not very aggressive
in his speeches and never deviates from the views of the central tendency and
the Chairman. We discount his measured “power,” especially given that he gives
so few speeches on the outlook and monetary policy. The influence of Governor
Warsh, on the other hand, is less surprising. He is the one member of the Board
who is perceived to hold somewhat different views than the Chairman,
specifically being more hawkish. Note, however, that almost all of his
influence came in a single speech that was taken as surprisingly hawkish by the
markets.
Members’ “Market Neutrality”
Now we look at the net effect on market rates for
individual members, measured as the sum of the market impact of his or her
speeches. This gauges the extent to which individual members, on net, raised or
lowered the two-year yield in 2009. In addition, this analysis allows us to
identify who were the most neutral in terms of the market response to their
speeches. Figure 4 shows the results.
Presidents Evans and Pianalto are tied
for market neutrality in this respect: On net, they had almost no impact on
yields. Perhaps the most striking observation here is that the majority of
members put upward pressure on yields.
Although it might be expected that members who push up
yields are seen as hawks, it is President Yellen who leads the pack, pushing
yields up more than ten basis points in 2009, followed by President Plosser. (Perhaps
she’s not as dovish as the markets believe!) That said, the speakers pushing
yields down included all of those who we regard as the most influential FOMC
members: President Dudley, Vice Chairman Kohn, and Chairman Bernanke. One
possible explanation for why their speeches tended to lower yields is that the
markets appear to have consistently priced in monetary policy tightening sooner
than what FOMC statements had appeared to suggest. As a result, whenever
expectations for tightening were ostensibly pushed back by these FOMC members,
the markets treated these events as surprises rather than mere confirmation of
what had already been said. Note, again, that what matters for the market
response is not just whether the member is perceived as a hawk or a dove, but
whether his or her speech surprised the markets, that is, the extent to which
each speech deviated from the message that the markets expected based on both
the perceived consensus view and where the speaker is perceived to be on the hawk/dove
spectrum.
Notable Speeches
Several speeches were
particularly notable for their policy content and impact on markets. The first
was Chairman Bernanke’s remarks at the Economic Club of New York in
mid-November. It lowered the two-year yield by four basis points. Two aspects
of his speech stood out to markets. First, he gave a stern warning that high
unemployment would hold back the recovery. Second, he hinted that monetary
policy might not be the best tool to deal with asset bubbles (if there were any),
citing uncertainty in detecting and dealing with them. But he did not rule out
the possibility of a policy response to asset bubbles if a supervisory and
regulatory response was not sufficient.
The second was
President Dudley’s speech, in early December. It lowered the two-year rate by six
basis points. His speech warned that growth would moderate in 2010 after a
strong performance in the second half of 2009, as temporary factors, such as
inventory investment and fiscal stimulus, stop providing support. A main
implication was that unemployment would remain high and inflation would stay
low, conditions that would warrant keeping the federal funds rate exceptionally
low for an extended period, echoing the language used in the FOMC statement.
This speech further reaffirmed that it was unlikely that the FOMC would act
anytime soon to raise the funds rate.
The third was
Governor Warsh’s speech in late September, previewed by his Op-Ed in the Wall Street Journal. It caused the
two-year yield to increase by four basis points. By this point in the year, the
Federal Reserve had openly expressed its intentions to stop easing and reverse
unconventional policies, although the pace and magnitude of the reversal was
still in question, especially with respect to the key issue of when the FOMC
will first hike the funds rate. Despite the fact that Governor Warsh’s comments
were fairly balanced, the punch line picked up by market participants appeared
to be: “Policy will need to begin normalization before it is obvious that it is
necessary, possibly with greater force than is customary.” Although this
statement alone may have appeared to suggest that a funds rate hike would be
sooner than previously anticipated, a closer reading of his full remarks
revealed that he merely intended to warn the markets against a hasty
celebration of the crisis’ end, as well as allaying concerns that inflation
expectations could be unhinged by too accommodative monetary policy.
Impact of Communications on Yields in 2009
We now look at the relative impact of different types of
FOMC communications on financial markets.
For all types of
communication, we measure the cumulative absolute change in the two-year
Treasury yield following the event. The period over which we compute yield
changes is generally fixed for each type of communication, although, as noted,
we adjust the windows to avoid including the effect of other market-moving
events, such as economic releases or other FOMC communications.
We also control for the effect of surprises with respect to monetary policy
changes announced in FOMC statements by using a simple regression of the change
in the two-year yield on the monetary policy surprise, where the latter is
based on changes in market-based policy expectations.
In 2009, the market impact of FOMC speeches stayed
elevated, as it had been during and the financial crisis in 2007 and 2008. On
the other hand, FOMC statements had a smaller effect than they did during that
period, although their impact remained elevated compared with the pre-crisis
period. We expect that market participants shifted their attention from
statements to speeches because, in an environment where the Federal Reserve
expressly and continuously states its intention to keep the target policy rate
at an “exceptionally low” level for an “extended period”, market participants
turned to FOMC speeches, which offer more insight into the range of views on
the economic outlook, on near-term decisions, and perhaps most importantly,
guidance about the duration of the extraordinary liquidity facilities and asset
purchase programs that the Federal Reserve introduced during the financial
crisis.
Although FOMC statements’ impact on markets appears to
have declined, they are still significantly more influential than FOMC minutes,
a pattern that is more consistent with the crisis years than during the last
expansion in 2005 and 2006. One explanation for why the markets treated
statements and minutes differently during the crisis is heightened sensitivity
to downside risks in an atmosphere where extreme tail risks had become
elevated. This may have encouraged market participants to put more emphasis on
the instant publication of monetary policy decisions and the language in
statements about the degree of downside risks, rather than the more detailed
information that comes three weeks later in the minutes. Another observation
consistent with this explanation is the decline in the “spread” between the
effects of statements and minutes between 2008 and 2009, possibly reflecting
lowered market angst about downside tail risks. It would be especially
interesting going forward to see if the shift in focus from minutes to
statements turns out to be permanent, or proves to be only a result of this
(hopefully) unique period.
Let us now turn to the
how these effects played out over time. Figure 5 shows the cumulative effect of
each form of communication.
On balance, FOMC communications (statements,
minutes, testimonies, and speeches) caused a five-basis-point increase in the
two-year Treasury yield in 2009. When broken down into components, we find that
speeches alone accounted for a 40-basis-point increase, which was almost
completely offset by testimonies and statements. As we discuss above, minutes
did not affect yields as strongly as statements, which divulge important
information in a timelier manner.
Much of the effect from FOMC communications came in the
second half of the year, even though there was arguably more turmoil in the
first half of the year, when persistently weak economic and financial
conditions motivated the Federal Reserve to ramp up its asset purchase
programs. Market participants appeared to become much more sensitive to FOMC
speeches starting in July, when the prevalent view was that the contraction of
the economy had started to show more signs of slowing. Perhaps the greater
sensitivity in the second half reflected the notion that, given signs that the
worse was over, market participants started to examine FOMC communications more
closely for signs of early removal of policy accommodation.
In 2009, market
participants scrutinized FOMC communications not just for hints about the
future direction of the funds rate but also for insights into prospective decisions
involving the unconventional monetary policy measures taken at the depth of the
crisis. This is especially relevant for concerns about the Federal Reserve’s
purchases of Treasury and agency securities, which have had the most direct
impact on yields. Indeed, we consider asset purchases to be another key lever,
along with the funds rate, of monetary policy these days. As such, just as we
control the impact of FOMC statements for the effect of changes in the funds
rate, we should also control for asset purchase announcements. For this reason,
we must account for the effect of the announcement of the Treasury securities
purchase program and the expansion of the MBS purchase program in the March
2009 FOMC statement, when the two-year yield fell 16 basis points over the
2-¼-hour window bracketing the announcement. (We have discussed previously the
effect of this announcement on Treasury yields.[4])
For simplicity, we attributed the entire 16-basis-point decline to the asset
purchase announcement. Figure 6 shows the impact of all types of FOMC
communications after we remove the effect of this the announcement.
This adjustment
takes away some downward pressure on yields that the statements exerted. The
remaining downward influence in yields originates from Chairman Bernanke’s
semi-annual testimonies and the other FOMC statements. As a result of this
adjustment, the total effect of all FOMC communications increased from 5 basis
points to 21 basis points.
And the Winner Is…
And now the part that everyone has been waiting for—the
winner of this “competition.” As in past years, we find it appropriate to
select more than one winner, given the different dimensions of market response.
The (unsolicited) “I Moved Markets” award is given to the
FOMC member who generated the largest cumulative absolute market response. As
expected, the winner is Chairman Bernanke. He will undoubtedly be pleased at
his continued dominance over other FOMC members in terms of total market
influence. Indeed, had it been otherwise, the Chairman would likely have been
quite displeased, not (only) because he would be embarrassed at having a lesser
impact, but because he might consider any other winner to have deserved the “I
Made the Most Noise” award for 2009.
As we noted, another meaningful measure of the degree of
influence of a member on the markets is who had the most market impact per
speech. The winner of the “Power Player of the Year” award in 2009 is President
Plosser, who impressively demonstrated more market power than even the
Chairman.
To avoid creating the appearance that the purpose of
these awards is to encourage FOMC members to design their speeches specifically
to have the largest possible market effect, make outlandish statements, or otherwise
intentionally surprise markets, we also recognize the member who spoke in a
balanced (and perhaps unsurprising) way so that the markets did not move much.
The last time we gave out this award was in 2006 to Governor Kohn, who, for
better or worse—we say better—is no longer market neutral. President Rosengren
is the (hopefully proud) winner of the 2009 “Market Neutrality” award.
(This might be a good time to remind FOMC members and
readers alike that these genuine certificates, issued by Macroeconomic
Advisers, have zero cash value, although we do not rule out the possibility
that they may offer valuable bragging rights at dinner parties.)
The Bottom Line
In 2008, we saw financial markets focus their attention
most on FOMC statements and Chairman Bernanke’s speeches. We expected this
trend to play out over 2009. While the markets continued to pay attention to
FOMC statements and communications by the Chairman, markets also reacted
strongly to speeches made by other FOMC members during intermeeting periods.
For example, the markets responded especially aggressively to speeches by
President Plosser.
We may be headed for an especially volatile period in the
markets in 2010, given the likely extreme market sensitivity to both the
incoming data and FOMC communications for perceived confirmation, or not, of
expectations about the timing of exit from the near-zero rate. The markets will
often be wrong, as with the interpretation of the increase in the discount
rate. But the markets do have a nasty habit at times of leading the FOMC’s own
views about monetary policy actions. So hold on for a possibly wild ride, and,
fortunately, lots of opportunity for FOMC members to “move the markets.” Let
the competition begin!
