Global financial services firm Morgan Stanley is speaking out about the Treasury’s recent announcement of another rake hike—but not in the way you’d expect. Rather than denouncing the Federal Reserve’s decision to increase interest rates for the third time this cycle, it’s the Fed’s communication strategy that’s leaving something to be desired, Morgan Stanley’s top strategist said.
According to Matthew Hornbach, Head of Global Interest-rate Strategy at Morgan Stanley, the early signaling of forthcoming rate hikes can’t—and will never—have the Fed’s intended impact. In fact, it could even constrain bond activity.
“As long as the Fed pre-signals rate moves,” Hornbach said, “the bond market will never react to ‘data’—both economic and market data—in the way the Fed intends … The Treasury market will be constrained in the manner in which it responds to the financial conditions process."
According to Hornbach, the history of early rate-hike announcements has primed investors to take their cues from the Fed—not data. In fact, had Janet Yellen not signaled the March rate hike last week, Hornbach said the market would have predicted it on its own.
"If the Fed had adopted this hands-off modus operandi earlier … we think the Treasury market would have already placed an 80 percent probability on a March rate hike,” Hornbach said. "Investors need to start setting their expectations differently, we think, and the Fed needs to lead the way sooner rather than later."
Overall, the Fed’s current communication strategy is overly effective, he said, and will cause Treasury yields to “remain subdued.”
A 2008 paper by Tobias Adrian and Hyun Song Shin sums up Hornbach’s sentiments well. The paper states, “If central bank communication compresses the uncertainty around the path of future short rates, the risk of taking on long-lived assets financed by short-term debt is compressed. If the compression increases the potential for a disorderly unwinding later in the expansion phase of the cycle, then such compression of volatility may not be desirable for stabilization of real activity. In this sense, there is the possibility that forward-looking communication can be counterproductive.”
The upcoming Federal Reserve’s meeting will take place on March 14-15.