The coming Fed hike and the problems with its communication

Last week, a slew of Federal Reserve officials talked up the likelihood of a rate hike in the meeting next week. Janet Yellen was at pains to stress that the reason for a likely rate hike was that the incoming economic data were as good as or better than Fed models predicted they would be.

Now market are putting the odds of a hike next week at 96%, a virtual certainty. But the very fact that Yellen and her compatriots commented on the likelihood of a rate hike at a specific meeting has been the subject of consternation.

Why it matters: While markets don’t like surprises, the Fed’s effectively pre-announcing a rate hike doesn’t sit well either. Many participants have said that it has the feel of an orchestrated campaign. And they complain that the data have not changed dramatically enough to warrant such a dramatic change in messaging. 

Basically, the complaint here is that the Fed’s next policy move will not be data dependent. The incoming data have not been significantly better than expected. So the market feels blindsided by the Fed’s change in tone. And while the hike, when it comes, will not be a surprise, the change in tone certainly was. In the end, even though the Fed was trying to telegraph its actions and eliminate surprises, market participants now feel less certain about the Fed’s reaction function, rather than more. And that could make policy less effective.