Understanding “Fed Speak” | Barita Insights | August 2, 2022

Analyst Insight

Introduction – The role of the Federal Reserve
Since the beginning of the pandemic, the United States Federal Reserve has been at the forefront of the news cycle due to their role in controlling and influencing the overall economic, and more specifically, the investing landscape worldwide. Before commenting on the actions taken by the Federal Reserve following the pandemic, the Federal Reserve System must be understood. The United States Federal Reserve, commonly referred to as The Fed, is the central bank of the United States of America. It is responsible for centrally controlling the monetary system of the United States and the globe’s reserve currency. Notably, the Fed is the most influential central bank in the world. The Fed was created in 1913, to alleviate financial shocks and crises through key monetary policy tools. The Fed works to promote a strong U.S. economy to target maximum employment and maintain stable prices. These two primary goals are referred to as the Fed’s “dual mandate” and are currently defined as sustaining the lowest level of unemployment that the economy can support while maintaining a stable inflation rate of 2% per year.

What is Fed Speak?
The Federal reserve is managed by a board of governors selected by the president of the United States. The head of the Federal Reserve is the Chair of the Board of Governors. Possibly the most influential Chair was Alan Greenspan who served as Chair from 1987 to 2006. Alan Greenspan is the reason for the now common term “Fed Speak”. Fed Speak describes Greenspan’s tendency to make ambiguous, and wordy statements as an intentional strategy to influence market reaction to the actions of the Federal Reserve. The benefit of this strategy is to manage investor and public expectations regarding current and future monetary policy. Through essentially confusing investors about future Fed moves, eventual policy decisions will carry a greater impact as markets would have been unable to adjust asset prices to future expectations. Essentially if markets did fully adjust to future Fed policy, the effect of the eventual policy decision may do very little to change real economic output and employment. Naturally, Greenspan’s strategy of intentionally confusing market participants was heavily criticized and following his tenure, a different type of strategy was popularized. Ben Bernanke, who replaced Greenspan as Fed Chair, introduced a strategy of forward guidance which gave investors more clear statements of intent for continuing monetary policy. This strategy is still used by the Fed today under incumbent chair Jerome Powell. Amidst the more transparent way the Fed currently addresses investors, the term Fed Speak has evolved to capture the overall technical jargon that is used by the Fed in describing monetary policy.

Keys to Understanding Fed Speak
A basic understanding of the general economic landscape and the monetary tools possessed by the bank can help the average person better understand this very technical speak.

Current Economic Landscape
Inflation has put consumers and businesses in a very difficult situation in 2022. A large contributor to the runaway inflation has been the supply shock caused by the war in Ukraine, however, inflation began reaching decade long highs in mid 2021 as a result of Governments’ response to the pandemic. Additionally, in order to preserve demand and economic strength in 2020 following the pandemic shutdowns, the US Fed triggered a period of the easiest monetary policy seen in history. Rates were slashed to zero while the money supply grew by 516%. While this was successful in triggering a Vshaped recovery from the pandemic induced recession, such aggressive increases in money supply naturally led to inflation in 2021. Now that inflation sits above 10% and a recession is looming; the Federal Reserve and Fed Chair Powell’s Fed Speak has been headline news during 2022.

Monetary Policy Tools
The Federal Reserve sets monetary policy by influencing the federal funds rate; essentially the rate banks charge each other for loans of excess reserves in the US economy. In order to influence this interbank rate, the Federal Reserve has three main tools:

• Open Market Operations-Purchases and sales of U.S. government debt and federal agency securities . The fed can drive rates lower and increase money supply by purchasing assets in the open market, increasing economic activity and inflation. Selling these assets works to tighten policy and reduce inflation.
• Interest rates – The rate charged to commercial banks on loans they receive directly from the Federal Reserve Banks.
• Reserve requirements – The amount of funds that a depository institution must hold in reserve, lower reserve requirements increase money supply, economic activity and inflation while higher reserve requirements tightens supply and reduces inflation. These tools are referred to every time the Fed Chair speaks as the Fed is currently tightening policy to curtail inflation. A common term for this policy of tightening is ‘hawkish’ action by the Fed. The easy monetary policy seen in 2020 is referred to as ‘doveish’ Fed policy. The major question at hand is whether the Fed can tighten policy and control inflation while also ensuring a soft landing, which simply means tightening while avoiding a recession.

Conclusion
The current actions of the US Federal reserve are critical in influencing the economic outlook worldwide, as well as the resulting movement in the prices of assets across the board including real estate, stocks, bonds and alternative investments. As a result, the Fed is in the news regularly and it is essential that investors can understand the intentions of the Central Bank by being able to parse through the jargon captured by Fed Speak.