A few months prior, I asked: What is the worst potential outcome if the Fed "loses credibility?" where a great answer pointed out that forward guidance allows a central bank to achieve counter-cyclical stabilization without actually needing to use any of their actual tools. I think Hank Paulson once said, "the market knows we have a bazooka, and that typically means we don't have to use it."

However with recent rate hikes exceeding what was telegraphed months earlier and to some extent priced in, the discussion has turned to: is forward guidance dead? Some Reuters coverage here. One comment from UBP:

"It's dead in the water," said Peter Kinsella, global head of FX strategy at asset manager UBP, who noted that he had taken "zero account" of forward guidance for months.

"It was a tool central banks used when inflation was very low, basically to say 'we will keep rates low for a long time' to encourage consumers to keep spending."

So perhaps the utility of forward guidance is only sufficient in a low inflation environment. Otherwise, monetary authorities will want to "surprise" the markets or at least have leeway to respond to data as it comes out rather than be locked in to one's word.

While there is some chatter about forward guidance being dead, looking at five year, five year forwards, it doesn't really look like that's the case. The latest readout is still right around 2%, suggesting the market still believes in the Fed longer-term.


I don't think it's a thought experiment anymore: more buy-side institutions are claiming forward guidance is changing. So my question now becomes, if that's the case, who will be most affected by this and why?

I think probably bond fund managers will be among those most affected: guessing those with long duration. But I'm guessing there's more to the story.


1 Answer 1


As AKdemy correctly notes in respose to your other question, the weakening of a central bank’s credibility decreases the effectiveness of forward guidance. Forward guidance can be applied to various outcomes such as the cash rate, the yield curve or inflation directly. Note that in regard to the latter, a non-trivial part of what drives inflation is actually inflation expectations; thus there is a risk that inflation becomes de-anchored from the policy target as central bank credibility weakens. The result overall is an increase in volatility of economic outcomes, such as inflation and output, as well as in financial markets.

So who would be worse off? First, central banks. The loss of forward guidance as a policy tool means that they would be less able to meet their policy target, further damaging their credibility. The second will be households, businesses and banks, because they will be less able to forecast future prices and rates. However, some actors will benefit. Financial market traders and market makers would be better off because they would profit from the increase in market volatility. (This may explain why most of the comments about the end of forward guidance have come from this corner.) It is not clear whether the government as a whole would be better or worse off under this situation. Though, particular administrations might be disadvantaged due to the political fallout of these developments.


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