There are many reasons for this. One of the first reasons is that whenever a government chooses a policy objective, the public responds to it. The public’s reactions are different, leading to differences in their behavioral tendencies. According to the Lucas Critique, whenever the government decides to change its policy objectives, the government’s actions affect the behavior of the public. So the behavior of the public changes accordingly, and the original behavioral relations change accordingly. We can’t use past estimates and past models to organize society. This is a very common effect.

As a result, governments are aware that to make economic policy effective, public expectations are quite worthy of deep understanding and control, which makes it easier and faster to achieve policy goals.

Among the world’s central banks, the Fed has made a lot of practical explorations in “expectation management”, through a clear definition of policy tools, a clear explanation of the conditions that should be met for the timing of policy adjustments, and regular interest rate meetings and the publication of meeting minutes, to effectively guide market expectations.

In brief, there are two main tools for the Fed in its expectations management. First, the Fed provoked a market reaction by releasing data that alternated between good and bad. Second, the Fed influences the market by constantly announcing future moves.

For example, previous data from the United States Bureau of Labor Statistics showed that 2.9 million new nonfarm payrolls were created in the United States during the 12 months from April 2023 to March 2024. According to the revised data released on the 21st, the number of new jobs in the United States decreased by 818,000 compared with the previous estimate in this statistical period. This brought total employment growth (excluding farm employment) to about 2.1 million from the previous estimate of 2.9 million for the 12-month statistical period, reducing the average monthly net job additions by about 68,000 to about 174,000 from about 242,000 for the period. At the same time, the seasonally adjusted CPI in the United States in July 2024 increased by 2.9% year-on-year, lower than expected and the previous value of 3%. Core CPI rose 3.2%, declining for four consecutive months, the lowest growth rate since 2020, in line with market expectations.

These releases have strengthened expectations of the Fed’s interest rate cuts, and capital markets have ushered in a sharp rally. The volatility of the United States capital market is due to the release of data and the revision of the data, and a large amount of wealth is captured under market volatility.

The second initiative we mentioned above is also quite subtle. For instance, in 2022, the Federal Reserve adopted an aggressive interest rate hike strategy, following the 25 basis points and 50 basis points in March and May, respectively, the Federal Reserve announced in the statement of the June interest rate meeting that it would raise the federal funds rate by 75 basis points to the target range of 1.50%~1.75%. This caused a further wave of growth in the capital market. After its interest rate hike ended, in November 2023, it paused interest rate hikes while saying that financial and credit tightening could affect the economy, and still “open the door” for future interest rate hikes.

This move prevents the outflow of high-interest funds deposited in the United States. At the same time, it has also stopped the cost of United States debt and interest rates from rising and has achieved excellent control over the economy.

Therefore, the expectation management is quite efficient, and of course it also requires a strong economic foundation and a free capital market.

By Le Tianyu