The Fed Games the System

Later this month, Federal Reserve officials on its Open Market Committee will begin to disclose their forecasts for interest rates. These members also will release what they believe is the most likely timing for interest rate increases. This action is taken in the name of transparency, but it actually may confuse the markets more than it helps them decide how to trade these plans for future rates.

One recent complaint about the Fed is that so much of its dealings are done in private. Investors are left to guess if and when the central bank will act on important issues like interest rate changes and qualitative easing. Fed watchers have battled over predictions about whether the Federal Reserve will follow its QE 2 plan with QE 3. The bank has been ambiguous in its statements about the matter. The decision will be based on the health of the economy. Who decides what that state is, though? The members of the Fed.

The danger in the Fed’s decision is that the new transparency is no better than the old secrecy. Members of the Open Market Committee are not bound by their forecasts. More governors have voted against consensus decisions in the past year. The direction of the Fed is not transparent, to some extent because of this dissent, even if tentative forecasts of its officials are.

The availability of forecasts will encourage the markets to trade on them. That may work — until circumstances change. A shift in the economy, particularly a rapid one, could make forecasts nearly useless. The markets, tracking the results of transparency, could be misdirected, no matter how innocent the Federal Reserve members are as the catalysts of that misdirection.

Is it better to know the future? As a trader or economist, it is better not to know it, if it is uncertain.

Douglas A. McIntyre