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  • Writer's pictureJoe Carson

Monetary Policy At A Crossroad: "Forward Guidance" Has Two Directions For The Policy Rate Path

Monetary policy is at a crossroads in what message it wants to send. Forward guidance is the Fed's communication channel about its future policy decisions. It became an important policy tool after the financial crisis as it conveyed policymakers' commitment to a "lower-for-longer" policy path, and it proved to be instrumental in easing financial conditions during periods of economic uncertainty.

But what happens when "forward guidance" has two directions in its policy rate path? Based on the last official projections, policymakers are telegraphing or promising one more rate hike in 2023, followed by four rate cuts in 2024 and five in 2025.

Higher official rates in the short run are a bearish signal. Still, much lower official rates in the future are a bullish signal, so are policymakers being too cute by playing both sides? And, in doing so, are they undercutting their near-term intent of being restrictive to bring down consumer price inflation to its 2% target?

Studies have shown that the "signaling effect" of future policy moves gets embedded into market prices long before the announcement. If the new policy is "higher-for-longer," then the updated official rate projections must change since a nine-to-one ratio of cuts versus hikes is "nirvana" for investors and unlikely to create the financial conditions policymakers want and need to bring inflation under control.

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