Q: We know it is always dangerous for someone in your line of work to say “This time is different.” Tell us why this is so, and show us some proof.
A: Ben Bernanke, the Chairman of the Fed during the Great Recession, moved the Fed’s decision-making process from secrecy to transparency. Prior to the Bernanke Fed, the FOMC members never (repeat, never) discussed what they might do regarding monetary policy. Since the Bernanke Fed, nearly every FOMC member openly discusses, not only the recent Fed moves, but their view of upcoming moves.
That transparency that coincided with an increase in volatility in interest rates. And that volatility has a huge impact on the bond market where conservative investors used to go for safety.
The first chart shows the Quarter over Quarter volatility in the 10-Yr U.S. Treasury Note. Note that the volatility was pretty subdued from the late 60s through ’07, then violently erupted with the Fed’s new “transparency.” And it looks to have become worse under the Yellen and now the Powell Fed.
You can also see this clearly if you look at the year over year changes in the 10-Yr Treasury yield.
Q: When you say the Fed became more “transparent,” what exactly do you mean?
A: By “transparency” I mean the Fed’s telling the markets not only their immediate monetary policy actions, but their future intentions. They do this through something called the Summary of Economic Projections (also known as SEP) – the market calls this the “dot-plot.”
I have three charts showing how the market has become volatile because of these “dot-plots.”
In the charts, the yellow dots are the individual projections of the Federal Funds Rate (the rate banks get charged on overnight reserve borrowings which is set by the Fed). There are 16 such dots (the 13 voting members and the 3 alternates). The green line is a plot of the “median” yellow dot.
The first chart is from the Fed’s September 2021 meeting. Note how there was hardly any movement forecast by the dots for 2022, i.e., from 0% to .25%. And even in 2023, the median dot was at 1.00%. Note also that the rate got as high as 2.50% in the “longer term.”
Now let’s look at the December meeting. Note that 2022’s median projection rate has risen to nearly 1%. But that the “terminal” rate remained at 2.50%. This led to some slight volatility.
The volatility really kicked in the March 2022 meeting when the dots shifted significantly higher as inflation became more and more of both an economic and political problem. Note that the 2022 median dot was now nearly 2% rising to 2.75% in 2023 and 2024 before falling back to just under 2.5% in the longer-term (2.5% is considered by most economists to be the “neutral rate” - neither accommodative nor restrictive).
Now let’s look at the last Fed meeting (June 2022). The dots have moved significantly higher once again, now to just under 3.5% at the end of 2022, rising to 3.75% in 2023 before falling back toward the 3.5% level in 2024, and then back to the neutral 2.5% level in the long-term.
All of these gyrations in the dots have cause the volatility. Prior to Fed transparency, there were no dots. The markets only knew what the Fed just did, not what they intended to do in the future. And, as you can see from the dot-plots, in the last four Fed meetings, the dots themselves have been volatile. So, it’s no wonder that interest rates have been volatile too!
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