Fed losing forecast edge is market game-changer, says Goldman Sachs Group

Risky assets are reacting more strongly to hawkish monetary shocks from the Federal Reserve in recent years, according to Goldman Sachs Group. The reason, ironically, is that the Fed is losing its forecasting edge.

The Fed’s relative predictive advantage versus private economists has declined in recent years as the higher quality and quantity of forecasters makes it harder for anyone, including Fed staff, to beat the “wisdom of the crowd,” Goldman economists including Jan Hatzius and David Choi wrote in a note April 20. It also means that after hawkish monetary shocks, such as a surprise rate hike or indication of higher rates, markets tend to react more negatively and consensus growth forecasts now decline, they said.

They found that “information effects,” or reactions caused by the Fed likely having insight that others don’t, have mostly gone away.

“The decline of information effects is perhaps one additional reason for why financial markets appear more reactive to Fed policy in recent periods,” the economists said. “Absent large information effects, the stock market should react more negatively to hawkish monetary shocks. We find strong evidence of this.”

The Fed has changed its tone significantly in recent months, softening slightly after a hike in December that helped fuel a market meltdown, then making a full dovish pivot over the following months as officials expressed concern about economic data. In March, the central bank’s rate projections fueled recession concerns and sent 10-year U.S. Treasury yields lower, though, they’ve since recovered to nearly the level seen before that meeting. The next rate move could be up or down, but there is likely to be a high bar to move either way.

“The key takeaway from recent Fed policy decisions is thatmonetary policy will be more dovish and supportive of growth,
not that the Fed has implied something negative about theoutlook that market participants currently do not know,” the economists concluded.