more powerful than every trader on Wall Street.

That would be the government's bank, the

Federal Reserve.

People listen to the Fed and they respond to what

the Fed says about the future.

When you listen to the Fed, you get at least one

studied outlook about what the future's going

to look like.

The Fed's press conferences, held every

six weeks or so, tend to cause swings in the stock

market.

Over time, central banks have moved from being

very secretive about what they're doing to

being more transparent about their policy

decisions. And part of that transparency is

signaling where policy is likely to go in the

future.

The Federal Reserve has hiked interest rates

seven times in 2022.

That's a relatively rapid pace.

This and a historic drawdown in the bank's

bond portfolio is weighing on stocks across

the board.

But there's a lot of other forces that are

affecting the economy.

By the time they usually start trying to slow

things down, it's gotten to a pretty bad

situation.

So how does the government's bank use

words to control stock prices?

And how can investors take a sound bite and

turn it into profit?

Forward guidance refers to public comments made

by leaders of the central bank.

Let's talk about forward guidance in two different

ways. The first way the Fed does forward guidance

is actually a very overt way, which is it tells

you how they think the economy is going to

evolve. The other way the Fed does so is in

language which can be very subtle.

Some economic models say forward guidance is

incredibly powerful.

The idea was that by changing people's

expectations of the future, you can change

their behavior in the present to make the

present better.

Here's how it works.

A member of the voting committee makes a

statement. The statement contains a vague but

definitive description about a forthcoming

action.

We side by side compare the statements that it

released month over month highlighting the

differentiation. And like a word, literally,

people in finance get hung up on a word.

There is a little bit of tea leaf crystal ball

that certainly goes into parsing the Fed words.

Investors cracking the Fed code are listening

for key phrases like:

"softening of labor market conditions"

or

"we expect to maintain an accommodative stance of

monetary policy until these outcomes, including

maximum employment, are achieved."

If you noticed what Powell said during the

pandemic, we're not even thinking about raising

interest rates. That's forward guidance.

When the Fed says, "we're buying $120

billion in securities per month across the

Treasury curve, that's also adding to

accommodation" that's forward guidance.

It's a very powerful tool.

Some of the most potent Fed statements are about

the future path of short-term interest

rates.

The Fed sets the interest rate that it pays on

reserves held by banks, sort of the same way your

bank sets the rate it pays on deposits.

There's this connection between short-term

interest rates that are closely connected to

monetary policy and the interest rates on

mortgages, auto loans, things like this that

would be more relevant to household decisions.

The Fed sets a target for these interest rates

about eight times a year. Over the past 20

years, the target has stayed low, with extended

periods at zero, a historical anomaly.

Economists say that taking this interest rate

below zero is a bad idea.

You can't set an interest rate less than zero

because people would just store cash in their

mattress instead of investing it with you.

And all this was because they didn't see the

ability to add accommodation to the

economy.

So instead, the Fed tries to set expectations with

their words.

Everybody does their best to set expectations going

forward, depending on what this guidance is.

And like the eight words that they change monthly

is something like everybody drools over and

tries to get their crystal ball and say, Oh

my God, that's what they're really thinking.

We would think that maybe you could get a couple of

percentage points. So effectively having -2%

interest rates through these alternative tools.

That said, people at the central bank say many

outside forces affect prices in markets.

It's not the case that the Fed can perfectly

control how investors or markets will respond to

its statements.

As you saw in 2022, when expectations were behind

the curve and suddenly they had to change policy

very quickly and very rapidly, the markets did

not like that at all and sold off very hard

because then there was this disconnect.

Stock market investors haven't always gotten

such explicit guidance from central bankers.

As subtle as you think it is now, it was way more

subtle way back when.

First of all, there was no forward guidance.

They never even put out a statement until the

early nineties. When you go back to that time

period, this is actually overt and hitting you

over the head.

You go back to the seventies and the

eighties, the Fed didn't talk about its policy

publicly very much at all.

It would finish a meeting in which it

decided to change the stance of interest rates

and it wouldn't tell anyone until eight weeks

later.

Forward guidance became an official policy tool

in the 2000s.

I would say that's in part due to Chairman

Bernanke's leadership, but also in part due to

the exigencies of the situation, of the

episode that occurred under his watch.

As an unprecedented housing crash developed

into contagion on Wall Street, the Fed took

interest rates to zero.

There's this constraint of zero.

And so instead of going lower, the FOMC included

language in their policy statements that interest

rates would remain low for a considerable

period.

People generally think that this had a positive

effect on our economy during those tough years.

And when you're sitting there at the zero lower

bound without an ability to lower interest rates

any further, any port in a storm.

If this has some theoretical possibility

of working, great.

In addition to forward guidance, the Fed tried

another new technique.

Large scale asset purchases or LSAPs.

The asset purchases swelled in Ben Bernanke's

time and nearly reached $9 trillion in the

pandemic. Now the bank is letting some of those

bonds mature.

It's what they're doing with their balance sheet

really matters. And I don't think they're ever

going to get their balance sheet back to

where it was pre 2020.

Central bankers know this technique could have

drawbacks.

Including the risk of impairing the functioning

of securities markets and the extra

complexities for the Fed of operating with a much

larger balance sheet.

Though I see both of these issues as

manageable.

Probably the balance sheet has more of an

impact on stocks than even interest rates in

that the balance sheet purchases or quantitative

easing provides liquidity to markets that

finds its way into stocks and ends up

increasing values. And so reducing that balance

sheet, quantitative tightening, probably has

a bigger impact on the stock market as changing

interest rates.

Much of the modern economy depends on the

Fed's ability to control narratives.

Well, central bankers, they want to have

credibility. They want to be believed.

One way to do that is to say what you're going to

do and then do it.

Some central bank policy makers, though, worry

that doing that will tie their hands too much.

They'd like to have the flexibility to respond to

unforeseen circumstances.

The bank did use this technique before the

Great Recession, however .

For example, the Fed provided forward guidance

as stagflation took hold in the 1970s and early

eighties.

The Fed did learn lessons from the seventies not to

ignore inflation until it becomes too big of a

deal.

But a failure to restore price stability would

mean far greater pain.

Powell has been indicating more recently,

Hey, trying to wake the market up and say, Hey,

this is not something we want to reverse on, which

was a mistake in the seventies and eighties.

And he has referenced that multiple times.

Wall Street's current down cycle kicked off

with a rare admission at the Fed.

It waited too long to act on inflation.

I fear that they took a gamble that inflation

wasn't too real at the beginning of 2021.

I think they know they gambled and lost and that

they have to do something serious in

order to get inflation back under control.

Even when the Fed pivoted rhetorically, as in the

language we were talking about, when it comes to

forward guidance, which Powell did, I believe, on

November 29th or 30th of last year.

It didn't really pivot very quickly in policy.

Rates went up on talk, and that is the power of

forward guidance. So the Fed played a bunch of

catchup. And what it did was it raised rates as

aggressively as we've seen since the 1980s.

As a result, the market has trended downward for

months.

To put it simply, the higher interest rates,

the lower relative value stock prices have.

These companies that year over year were producing

20% returns that people felt so comfortable with.

And then suddenly the giants of the investment

industry started to fall. You had Apple and

Amazon, stalwarts, making tons of money for

decades, suddenly down 40%, 50% on the year.

Tesla is down 50%.

Got some a little bit. Microsoft's held up a

little bit better. When rates are going up, we're

going to see some harder times, which then means

maybe stocks that aren't going to make as much

money.

Some speculators in the stock market hope that

the bank will pivot from that plan.

We do think the Fed is going to pivot harder

than they're saying right now.

The pivot has been redefined three times.

First, the pivot was one with the Fed pivot to

cutting rates. Then this pivot was defined as when

would the Fed pivot to pausing its rate hikes.

Now we have another definition of pivot out

there, which is when will the Fed pivot to

reducing its its rate hikes.

Chair Powell has talked about getting rates

higher and keeping them there longer, and yet the

market still seems to be holding out hope for a

pivot. And so I think t here is a disconnect.

It's been going on for some time.

Many Wall Street advisors have a suggestion" don't

fight the Fed.