(Adds comment on rates, background on market reaction)
By Jonathan Spicer
NEW YORK May 6 The Federal Reserve should
expect more "bumps in the road" as financial markets react to
increasingly less precise communications from the U.S. central
bank, a top Fed policymaker said on Tuesday.
In a speech, Fed Governor Jeremy Stein recalled last year's
abrupt run-up in market-wide borrowing costs and warned that
even the most deliberate communications from the central bank
cannot prevent such reactions as the time to tighten monetary
The Fed has kept its key interest rate near zero since the
worst of the financial crisis in 2008, and since then has tried
to telegraph how long it will keep it there. While this
so-called forward guidance has helped stimulate parts of the
economy, including housing, the Fed has made a series of
adjustments to its message that have often confused investors.
"As policy eventually normalizes, guidance will necessarily
take a different form; it will be both more qualitative as well
as less deterministic," said Stein, who leaves the Fed later
In part because of "levered bets" among big-money investors,
he said, "we may have some further bumps in the road as this all
The Fed rolled out its latest version of forward guidance in
March when it said rates will likely stay near zero for a
considerable time after it ends its stimulative bond-buying
program. It ditched a reference to a 6.5 percent unemployment
rate as a threshold for considering a tightening, essentially
adopting a more qualitative approach.
The central bank expects to halt its asset purchases later
this year and to raise rates some time next year. The changes
will represent a reversal of the most accommodative U.S.
monetary policy ever.
Addressing a question on rates from an audience of bond
traders, Stein said weaker U.S. productivity and potential
growth could point to a lower average federal funds rate over
the medium-term horizon. The fed funds rate is the central
bank's primary policy tool, and it has averaged about 4 percent.
Stein, a governor who in two years at the Fed has pushed for
policy decisions to more formally consider financial
instabilities, said it is unrealistic to expect that "good
communication alone can engineer a completely smooth exit from a
period of extraordinary policy accommodation."
In the nearer term, though, he said the Fed is well
positioned given that the market "almost uniformly" expects
policymakers to "continue tapering our purchases in further
measured steps over the remainder of this year."
Indeed, yields on 10-year U.S. Treasury notes have remained
low, around 2.6 percent over the last few months, suggesting for
now that investors and the Fed under Chair Janet Yellen are on
the same page. However, those borrowing costs jumped a year ago
when then-Chairman Ben Bernanke suggested the Fed could start to
trim the bond purchases in coming months.
Attempts to overly manage communications to reduce market
volatility may prove "self-defeating," Stein added.
"There is always a temptation for the central bank to speak
in a whisper, because anything that gets said reverberates so
loudly in markets," he said. "But the softer it talks, the more
the market leans in to hear better and, thus, the more the
whisper gets amplified."
(Reporting by Jonathan Spicer; Editing by Leslie Adler and Ken