Connecting the Dots: Market Reactions to Forecasts of Policy Rates and Forward Guidance Provided by the Fed

32 Pages Posted: 1 Nov 2016 Last revised: 14 Nov 2016

See all articles by Michelle Bongard

Michelle Bongard

Board of Governors of the Federal Reserve System

Gabriele Galati

De Nederlandsche Bank

Richhild Moessner

Bank for International Settlements (BIS)

William Nelson

The Clearing House

Date Written: October 24, 2016

Abstract

This paper compares market reactions to forecasts of the policy rate path provided by FOMC participants (“dots”) in the Summary of Economic Projections (SEP) with those to forward guidance provided by the FOMC in its statements. We find that market expectations of the time to lift-off from the zero lower bound are significantly affected in the expected direction by surprises in SEP dots and in forward guidance. We also find a significant impact of macroeconomic news on market participants’ expectations of time to lift-off. These results are consistent with forward guidance about policy rates and SEP forecasts each contributing to the public’s understanding of future Federal Reserve monetary policy, and with the conditionality of both forms of communication about future policy rates being understood. We also present evidence that market expectations concerning the time to lift-off are influenced by the maximum time to lift-off implied by forward guidance, the SEP and the economic outlook. An appendix provides the FOMC’s forward guidance after each meeting from January 2012 to September 2015 and our interpretation of the implied days to lift-off.

Keywords: forward guidance, policy rate forecasts, zero lower bound

JEL Classification: E52, E58

Suggested Citation

Bongard, Michelle and Galati, Gabriele and Moessner, Richhild and Nelson, William, Connecting the Dots: Market Reactions to Forecasts of Policy Rates and Forward Guidance Provided by the Fed (October 24, 2016). De Nederlandsche Bank Working Paper No. 523. Available at SSRN: https://ssrn.com/abstract=2860044 or http://dx.doi.org/10.2139/ssrn.2860044

Michelle Bongard (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Gabriele Galati

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Richhild Moessner

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

William Nelson

The Clearing House ( email )

1001 Pennsylvania Ave
Washington, DC
United States

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