Forward guidance - frankly garbage

This morning, Asian markets are expected to open a little softer following US equity weakness overnight. Newswires are putting the weakness in the US down to a couple of things:

1. Comments from the Fed's Raphael Bostic that the renewed spike in Covid-19 cases may threaten the pace of economic recovery and;
2. Further evidence that case numbers continue to rise in the Southern belt states as well as death figures, where, not so much nationally but in some of the most affected states, the 7-day moving average of daily deaths from Covid-19 have begun to creep higher.

I wonder though, whether this is the usual case of financial journalists observing the market action, and then looking for an appropriate donkey to pin the market's tail on?

There is another suspect for the market's weakness, but let me get there in a roundabout fashion, because another Fed member, Loretta Mester also remarked that the impact of the upsurge in virus cases was causing activity in her district (Cleveland Fed) to level off, and pointed to the need for more fiscal support.

But when a Fed member says, "Things aren't good, can we have some more fiscal support please?", that should tell you something about the availability of monetary options, and this is where we get the clinching remarks.

Richard Clarida, Vice Chair of the Fed, said yesterday that should they (the Fed) need to provide more stimulus, the Fed had plenty of available tools, but then listed first in his arsenal (as well as buying more assets) "forward guidance".

Here's the thing, around the world, many central bankers have asserted that forward guidance is a tool in their arsenal. Let me tell you something. 99% of the time, it isn't. And that's because financial markets aren't stupid.

In fact, financial markets usually point to Fed cuts, or hikes, long before the Fed itself realizes it needs to make them, as was the case back in late 2018 when it saw through the Fed's projection that rates would keep rising through 2019. Forward guidance then, in terms of the dot plot and other associated remarks, was simply forward garbage.

The idea of forward guidance is that by telling markets that rates will remain very low (and then comes the tricky part) until such-and-such a condition has been achieved (sensible) or such-and-such a date had been reached (not credible), additional stimulus can be achieved by helping longer term bond yields to decline (normally the Fed only has traction at the front end of the yield curve).

But whether contingency-based or time-based guidance, there is only any market benefit to such announcements if the market was not already (as is usual) way ahead of the central bank in question. There are times (infrequently) when markets do get things wrong, and when a helpful word here or there can provide a useful nudge to get them back on the right track. But as a general option to be used to provide additional stimulus, it usually doesn't have any firepower whatsoever.

The Implied rates in the US from the OIS curve are currently flat at about zero to slightly negative right out to 2022, so unless the Fed really is going to engage in substantially negative interest rates before then (and it doesn't sound as if they are), then they have nothing to tell us.

Indeed, you can also lay quite a lot of blame of increased volatility at the feet of misplaced forward guidance, for example, the bond market taper tantrum in 2013 as the Fed had to backtrack on some of the claims it had previously made for policy as the economy recovered. This led to a step up in rate expectations, which wouldn't have been necessary if the Fed had not meddled in the first place by making exaggerated claims.

In short, when the Fed tells you, "Don't worry, forward guidance is here to help". It is actually time to be worried. But don't get too alarmed. By this time tomorrow, equities will probably have forgotten all this and found another reason to rally.

Another story is doing the rounds today, that I feel obliged to mention, bu which has the ring of market "propaganda" to it. The reported story concerns the US allegedly considering ways to undermine the Hong Kong dollar by making it harder for Hong Kong's financial institutions to access US dollars during liquidity squeezes.

The HKMA has a USD swap agreement with the US Fed, but HK FX reserves have always been enough to defend the peg in times of stress, so this is theoretical support mainly, not practical day-to-day support.

Importantly, this idea seems to be being circulated at a fairly low level in the US administration, and does not yet seem to be being seriously considered within the White House as far as we understand.

So although this seems like a non-story, it may get some more airplay over the coming days, so it's worth keeping an eye on.

In neither the G-7, nor Asia, does there appear to be anything on the calendar today that looks worth a comment, though I am conscious that it is on just such occasions, that geopolitics or market gyrations fill the void, so be careful out there.