for·ward [pronounced: fawr-werd]
adverb Also, forwards.
1. toward or at a place, point, or time in advance; onward; ahead: to move forward; from this day forward; to look forward.
2. toward the front: Let’s move forward so we can hear better.
3. into view or consideration; out; forth: He brought forward several good suggestions.
4. toward the bow or front of a vessel or aircraft.
5. ahead
guid·ance [pronounced: gahyd-ns]
noun
1. the act or function of guiding; leadership; direction.
2. advice or counseling, especially that provided for students choosing a course of study or preparing for a vocation.
3. supervised care or assistance, especially therapeutic help in the treatment of minor emotional disturbances.
4. something that guides.
5. the process by which the flight of a missile or rocket may be altered in speed and direction in response to controls situated either wholly in the projectile or partly at a base.
Forward Guidance is this season’s must have accessory. Adopted by central bankers all over the world, FG (let’s call it by an acronym as finance is full of them), is all the rage.
And yet like so many fashions (harem pants, ponchos, juicy tracksuits, UGG boots, jeggings) in retrospect it will be dammed. History has been unkind to many must-have-it-fads, FG is likely to experience the same.
- harem pants
- The must have item of the fall
So what do I have against FG?
In my opinion:
It does not work to bring down long rates.
Its effect even on future expectations of short rates is limited.
I am sceptical in its ability to stimulate demand.
And it doesn’t provide much forward guidance either.
Apart from that it may be a marvellous!
According to the Federal Reserve, forward guidance supports the economic recovery by putting “downward pressure on longer-term interest rates and thereby lower(ing) the cost of credit for households and businesses, and also help(ing) improve broader financial conditions.”
Remember of course that Central Bankers only control short rates, not the longer rates that are set by the market. So forward guidance is an attempt by central bankers to influence the long end of the yield curve, of which many financial products are priced.
Effect on long rates:
At its December meeting of last year, the Fed moved from date based guidance (Fed Funds rate would stay low until at least through to mid 2015) to guidance based on economic variables (unemployment staying above 6.5% and future inflation “no more than 0.5% point above the committee’s 2% long run goal”). And yet the 10 year UST rate has gone from 1.75% at the beginning of the year to 2.89% on Friday. The market is much more worried about Fed tapering and ignoring Forward Guidance on tightening.
In the UK, Mark Carney arrived at the beginning of July and by August had officially announced forward guidance based on the unemployment rate too. And yet the 10 year gilt yield – like the UST – has also increased from 2.4% on 1st July to 2.7% on Friday. Buyers of long dated gilts are worrying that forward guidance (low interest rates for longer) will allow a higher inflation rate.
In Europe, the big moves in long term rates have been driven by another policy altogether – the OMT. At the height of the EZ crisis 10 year borrowing costs for both Italy and Spain went to around 6.5-7.5%. That’s despite a 0.5% rate set by the ECB. It was Mario Draghi’s “Whatever It Takes” speech that has really brought these rates down and not his latterly adopted policy of forward guidance.
Effect on short rates:
Clearly the arrival of Mark Carney has had a dramatic effect on the expectation of future base rates in the UK. Before he arrived markets were just about pricing in the first rate rise by the end of this year. His speech 4 days into office changed all that, together with his forward guidance speech in August. At one point markets were pricing in the first rate rise in 2016 as Carney proclaimed. But after the stronger recent economic data, markets are now pricing in a rate rise by the end of 2014 – much sooner than Carney’s 2016. All the thousands of market players don’t believe Carney’s Forward Guidance either. I am not alone in my scepticism.
And in the eurozone, Mario Draghi has a term for markets ignoring his FG –“passive tightening”. When rate markets react to stronger EZ economic data, Draghi gets irritated and tries to talk them out of it. And of course, Draghi’s recent Forward Guidance was driven by the markets anticipating tightening sooner than he sees.
Effect to stimulate demand:
Fed: “forward guidance helps to make monetary policy more transparent and predictable to the public”. This is also what Mark Carney believes but I am a little more skeptical.
Does FG stimulate companies to spend? An educated Finance Director will know far more about central bank policy and rate expectations than an ordinary citizen. But what we know from the downturn is that companies have en masse paid back debt, strengthened their financial position and refinanced debt to low interest rates. What we haven’t seen is a boom in capital expenditure – quite the opposite – profit margins are high because money has not been invested. What businesses bosses really need to see is signs of a stronger economy to get them to spend their cash.
So does the General Public react to Forward Guidance? Does Carney speak to the people? Again I am sceptical. And that is because time and time again we discover that most ordinary citizens are remarkably financial illiterate. This week saw another bank mis-selling scandal in the UK. 23 million card and identity fraud protection policies were mis-sold to 7mn customers. Well there are only 63mn people (including children) in the UK. Almost a third of households bought a policy that was not needed as once a credit or debit card is reported stolen or lost, then it’s the bank that takes the losses, not the individual. With such a lack of financial knowledge, can central bankers really speak to ordinary consumers on forward guidance? A Markit survey of approximately 1500 individuals suggests that Carney’s words have effected people’s expectations of future interest rates. The number of households anticipating a rate rise within the next two years fell to 40% compared with 53% in July. But note that most are still expecting a rate rise sooner than Carney’s 2016 – again a bunch of non FG believers. And the survey does not indicate whether that change to rate expectations has actually increased the household’s spending. And also a quarter of those surveyed had no idea whatsoever on rates!
And then of course, forward guidance is not forward guidance if it is data dependant which it is. It is just old fashioned interest rate policy (dependent on economic news) but dressed up in a new way (much like any new fashion). But the biggest problem I have with forward guidance is that it may prove to be the name under which inflation is tolerated and rates not raised quickly enough.
However like all fashions, it does not matter what FG does or does not do, its all about being in on the latest thing. Judging FG on that basis, it is terrifically trendy.
I was having difficulty finding a song or video this week. And so I have chosen a Monty Python sketch – Vocational Guidance Counsellor. Clearly it has a tenuous link to FG but it is very funny.
Monty Python – Vocational Guidance Counsellor:
