Industry News

Reporter Chen Jiayi

 

Every summer, the sea breeze in Sintra, Portugal always touches the nerves of global financial markets.

 

At this year's Sintra Forum, the heads of central banks from the United States, Europe, the United Kingdom, and Canada participated in policy group discussions on the same stage. At first, the market was only focused on raising interest rates, paying attention to Federal Reserve Chairman Kevin Walsh's overseas debut. When the four central bank governors had a dialogue on stage, the market suddenly realized that a more profound change was happening - the era of "forward guidance" was gradually coming to an end, and the "data-driven" decision-making model was fully emerging.

 

Walsh reiterated on stage that the Federal Reserve will no longer provide forward guidance. European Central Bank President Christine Lagarde admitted that her biggest policy regret is that she was often forced to follow the forward guidance given earlier in the past. The attitudes of Bank of England Governor Bailey and Bank of Canada Governor MacLehose in downplaying forward guidance are also highly consistent.

 

Rigid guidelines constrain the central bank's' hands and feet '

 

According to the official website of the Federal Reserve, forward guidance is a tool used by central banks to communicate the direction of future monetary policy to the public.

 

Initially, forward guidance only stayed at sporadic attempts by individual central banks. In 2000, under the leadership of then Federal Reserve Chairman Greenspan, the Federal Reserve began regularly incorporating assessments of potential economic risks into its policy statements. In 2003, the Federal Reserve added guidance on possible paths for monetary policy.

 

Until the 2008 international financial crisis, forward-looking guidance began to appear more widely in the public eye. At that time, the policy interest rates of major developed economies reached the lower limit of "zero interest rates", rendering conventional interest rate tools ineffective. Former Federal Reserve Chairman Ben Bernanke introduced forward guidance and institutionalized it, elevating communication from an auxiliary tool to a core tool to compensate for the lack of operational space in monetary policy. In 2013, the Bank of England and the European Central Bank successively introduced forward guidance.

 

Dong Zhongyun, Chief Economist of AVIC Securities, told Shanghai Securities News reporters that when short-term interest rates reach the lower limit of "zero interest rates", the central bank will continue to stimulate long-term interest rates by influencing market expectations of future interest rate paths. Monetary policy is essentially the management of expectations, and forward guidance is the operational embodiment of this concept. In addition, forward guidance also serves the institutional function of enhancing transparency and accountability, which helps to strengthen the independence of the central bank and stabilize financial markets.

 

In longer cycles, central banks around the world use forward guidance as an auxiliary tool for monetary policy, and the market also sees it as an effective reference for investment. Unconsciously, traders have also formed an exclusive "interpretation system of central bank discourse", breaking down subtle changes in policy wording word for word, tracking every speech of central bank officials, and predicting the pace of interest rate hikes and cuts based on a dot matrix.

 

However, this has also given rise to serious market path dependence. Dong Zhongyun said, "The market's excessive reliance on forward guidance has resulted in structural distortions

 

The root of this change lies in the collective reflection of central banks around the world on the shortcomings of forward guidance - in a macro environment full of uncertainty, the forward guidance that was once used to stabilize expectations has become a shackle that restricts central banks from adjusting monetary policy.

 

Rigid guidance may lead to the future monetary policy path being locked at inappropriate interest rate levels, "said Mingming, Chief Economist of CITIC Securities. Due to the high degree of uncertainty in the global macroeconomic environment and the difficulty in predicting the impact of artificial intelligence, the central bank's provision of forward guidance may weaken the flexibility of monetary policy.

 

From 'Forward looking Guidance' to 'Framework Guidance'

 

At the June interest rate meeting, the Federal Reserve began to weaken its forward guidance, not only deleting all forward guidance content, but also significantly reducing the length of policy statements. In addition, Walsh did not disclose his personal interest rate chart forecast.

 

The latest minutes of the Federal Reserve's monetary policy meeting also show that most officials support shortening the post meeting statement and agree to remove language implying the next policy direction.

 

After abandoning forward guidance, Walsh stated that the Federal Reserve will return to being "data-driven". Walsh said that forward guidance is "not suitable for the current policy environment", and the Federal Reserve is "opening up a new path". In the future, it will rely on a new real-time data system to formulate monetary policy, no longer relying on official statistical reports with lag and bias.

 

The new path designed by Lagarde for the European Central Bank is to shift from traditional forward guidance to framework guidance. In the obvious view, framework guidance is to explain to the market the methodology, monitoring indicators, and analytical framework on which monetary policy decisions are based, rather than pre committing to interest rate paths.

 

Lagarde said that the current policy response function of the European Central Bank has been fully understood by the market, and financial markets can adjust their financial conditions based on newly released economic data, thereby playing a role in monetary policy to some extent in advance.

 

Dong Zhongyun believes that in the future, the communication between the central bank and the market may show the following development directions: firstly, reducing the frequency of public communication and emphasizing more on the professionalism of the central bank; Secondly, the market will form expectations more through understanding the central bank's way of thinking rather than relying on direct statements; Thirdly, data dependency decision-making will be comprehensively strengthened, and the introduction of real-time data systems will be accelerated.

 

Future may amplify market volatility

 

The central bank's shift from forward guidance to framework guidance will encourage investors to conduct macroeconomic analysis and judgment based on frameworks and the latest data, and will also drive market attention back to the data itself, rather than overly relying on signals implied by the central bank's interest rate path. Clearly, future asset pricing may also be more closely linked to macroeconomic events and economic data itself, and framework guidance may promote more efficient market operations.

 

China International Capital Corporation (CICC) wrote in a research report that excessive simplification of forward guidance may compress the market's space for obtaining forward information. In the current context of high economic uncertainty, the reduction of information may not necessarily equate to an improvement in clarity. This shift from the central bank no longer 'telling the market what to do' in advance, but allowing the market to make independent judgments based on the decision-making framework and real-time economic data announced by the central bank, may increase market volatility in the future.

 

However, analysts also say that weakening forward guidance does not mean that the central bank is completely silent. Dong Zhongyun believes that Walsh's reform strategy is not to completely eliminate communication, but to maintain policy quality by strengthening the prudence of internal decision-making, while reducing hard commitments to future interest rate paths. This strategy can be seen as a moderate return to "constructive ambiguity" - neither returning to black box operations, but also retaining sufficient policy flexibility to deal with unforeseeable shocks.

 

Returning to the venue of the Sintra Forum, when the host finally raised the question of "Does anyone still think there will be a rate cut now?", the four central bank governors laughed but remained silent.

 

The old narrative has come to an end, and a new era without early "spoilers" from the central bank is slowly approaching.

 

(Editor in charge: Zhu Xiaohang)