Regions

Poor Fed communication risks market 'snap back,' Plosser warns

February 20
5:41 PM 2015

Verbal missteps by the U.S. Federal Reserve have increased the risk of a volatile market reaction when the time comes to raise interest rates, the outgoing president of the Philadelphia Fed said in an interview on Friday.

A week before stepping down from the U.S. central bank, Charles Plosser said the Fed can start sending the right message at a policy meeting next month, when he speculated it will likely drop a reference to patience in describing its approach to tightening monetary policy.

With interest rates near record lows and investors globally closely eyeing the Fed, just how deftly Plosser's colleagues handle that communications challenge will determine how smoothly they can pull off the first rate hike in nearly a decade.

"I worry the risks of volatility or snap-backs when the Fed actually moves is probably greater than it needs to be," Plosser said in his third-floor office at the Philadelphia Federal Reserve, a few paintings and books already packed in wooden and cardboard boxes.

While several Fed officials have pointed to mid-2015 as a reasonable time for the first rate rise, investors see it coming anywhere from September to early next year, according to futures contracts. The market also expects a less aggressive series of hikes than is implied in Fed forecasts.

Plosser, who has opposed ultra-easy policies for much of his eight-and-a-half years at the Fed, said the gap between the market's expectations for future rate hikes and that of the central bank "is not trivial." He added: "I worry that the communications and signals that the Fed has sent haven't been effective at closing that gap any more than it has."

The Fed repeated at its last meeting in January that it will be "patient" as it considers when to raise rates. But a steadily improving economy and a strong January jobs report have left many economists predicting it will drop that word soon.

"It's pretty obvious that the committee is going to have to deal with the 'patient' language at the next meeting, and do something about it," said Plosser.

Leaving the word in the statement following the upcoming March 17-18 meeting, he said, would send the signal that rates will stay near zero until July at the earliest. "I don't know why we'd want to do that... They've got to find a way to communicate something that doesn't take June off the table."

The economy was stung by an abrupt jump in borrowing costs when in 2013 then-Chairman Ben Bernanke said in congressional testimony the Fed could taper its bond purchases in coming months, causing the central bank to backtrack with soothing words. Fed Chair Janet Yellen is set to testify before Congress next week.

Minutes of the Fed's January meeting, released earlier this week, revealed a surprising amount of concern over raising rates too quickly, prompting a drop in U.S. bond yields and boosting market bets on a later tightening.

Plosser, a former economics professor who has long stressed the need for clear Fed communication, said he was surprised investors put "so much weight" on the three-week-old minutes when a subsequent employment report likely "undid the concerns that may have arisen" about the labor market.

Plosser said his biggest contribution to the Fed was probably helping usher in a 2012 statement that formally set a 2-percent inflation target. Beyond saying he would spend time with his grandchildren, he did not discuss post-retirement plans. No successor has been named.

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