The Power of Words in Moving the MarketsDecember 7, 2015 5:23 pm
Markets, like most investors, need to have their financial concerns answered in simple, understandable language. Once again, last week, we saw the power of words inflict volatility on the markets. It wasn’t the first time a central banker was caught by miscommunication.
Last September, Janet Yellen, the Federal Reserve Chair, faced a press conference and, by many accounts, bungled her message. She had just come out of a Federal Open Market Committee Meeting where the Fed has decided not to raise interest rates. This was counter to the expectations of the markets, which had convinced themselves that the first rate hike since the financial crisis was at hand.
By many reports, it had been a contentious meeting, complicated by the introduction of international factors. I suspect that consensus had been hard to reach, and Yellen was stuck having to explain the various sides of the argument. The result: her answers came across as muddled; the outlook unclear. The S&P reacted decisively dropping 5.7% over the next ten days before rebounding. Yellen’s press conference was blamed by many for the descent.
Americans like their leaders to be confident and straight forward. Most people don’t want to know all of the intricacies of decision marking – just why a particular decision was reached and what to expect. (Plus no surprises, please.)
Yellen and her colleagues spent the fall unwinding the mistakes of the September press conference, spelling out a new message that a December rate hike was not only on the table, but increasingly likely. And last week Yellen gave an upbeat outlook for the US economy and signaled that the Fed was close to raising rates.
Mario Dragi, the President of the European Central Bank (ECB) ran into a clarity issue this past week. Coming into Thursday’s ECB policy meeting, markets had convinced themselves that Draghi was about to announce substantial expansion of monetary easing. He fell short of expectations and the Eurozone markets plunged 4.2% (local currency). Friday, he clarified his thoughts, with a more direct statement, “There cannot be any limit to how far we are willing to deploy our instruments, within our mandate, and to achieve our mandate,” and the European markets responded positively.
Note that for both Yellen and Draghi, markets had set their own very specific expectations prior to the central bank policy meetings. These were only partly driven by the Federal Reserve and the ECB themselves. Markets, like people, have imaginations, hope and fears, which if not contained can take on a life of their own, making the challenges world leaders face all the more demanding. The result? Volatility resulting from language miscues.
While I may sound critical of both Yellen and Draghi, I am actually very sympathetic to them. Both of these central bank leaders have been practicing, refining, and enhancing their communication tool since they took office. And they still have a hard time meeting market expectations for transparency! Markets are not the most forgiving of audiences.
Part of the problem is that Yellen, Draghi and their cohorts at the other central banks are attempting to provide “too much information” in the way of explanations and justifications. Hearings and press conferences drag on allowing for missteps and contradictions. The take-away for the markets is often less than clarifying.
Another problem is that the markets are uncertain as to how they will react when the Federal Reserve does raise interest rates. The current low growth, low interest rate environment is not the normal backdrop for the initial rise in rates. The word “unprecedented” gets thrown around a lot. Everyone wants the answer to the question, “What will the future investment environment look like?” That may not be possible until we get there, yet markets expect central bank leaders to clue them in.
Those of us in the financial services industry are tasked with setting realistic and clear expectations. Our clients deserve the best explanations of what we are thinking and advising, in order to help them make reliable decisions. Often times this means we need to use direct language, translate elaborate information into manageable messages and check in with the clients regularly to ensure that their understanding is clear.
The central bank leaders are no exception to this best practice. They have enormously challenging jobs that are as much about communication as they are about policy. All the more so going into next year and especially if the Federal Reserve decides to raise rates at its December 15-16th meeting. Managing market expectations may be key to limiting volatility in 2016, and simple, clear language may be the best tool. One can never be too careful with what one says.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.