Words Matter When It Comes To Central Banks

On the surface, there was nothing exciting about the Bank of Canada’s (BoC) January 2024 interest rate announcement. As expected, the central bank kept its overnight rate at 5 per cent, the same level it’s been at since last July. But those who spent an extra few minutes reading the BoC’s press release got their first real clue that additional rate hikes may now be off the table.

The BoC release didn’t include a word about ending increases in its release. It was one key phrase it left out
that made news. The previous month it wrote this: “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed.” In January, the BoC published a nearly identical paragraph, but it removed the reference to raising the policy rate.

The 11-word omission is essentially acknowledging that there will likely be no more rate hikes this cycle unless inflation were to re-accelerate, says Eric Savoie, an Investment Strategist with RBC Global Asset Management. The change in messaging is significant because it’s the first time since 2022 that Canadians haven’t had to worry that their borrowing costs are going to rise even more. “It’s these really tiny omissions, or the addition of one or two words that can be a really big deal.”

Investors who want to know what central banks will do next may wish to pay careful attention to what they say, and how they say it. Rate increases can impact stock and bond prices. “Anyone who is watching can get a feel for whether [or not] central banks feel like they should be changing their policy,” says Savoie.

Words to live by

Whether it’s the wording in a press release, a post-announcement press conference from BoC Governor Tiff Macklem or a statement by Fed Chairman Jerome Powell, central bankers will often reveal a lot of information about how they’re thinking about rates and the economy. For someone like Savoie, who keeps a close eye on everything that’s said, by the time of the announcement, he’ll already have some idea as to what will be revealed.

There are a few key areas to focus on, he explains. The first is what metrics central banks are tracking. While everyone knows they’re looking at inflation, sometimes they look at the overall consumer price index and other times they’re watching core consumer price index, which excludes food and energy – two areas that can see dramatic changes from month to month. “They’ve mentioned six or seven different inflation metrics they’re looking at, so we’re tracking those, too,” says Savoie. “It’s important to know exactly what they’re looking at.”

You may also want to know what the central bank’s objectives might be when it comes to reducing inflation, says Savoie. Both the Fed and the BoC have said that they want prices to increase by about 2 per cent annually, but in a February interview with The Logic, Macklem did say that he will study whether or not they should increase their inflation target at some point in the future – a comment that caught the attention of many policy watchers.

As well, a simple phrase like “sufficiently restrictive”, or a seemingly obvious one such as “inflation is too high” carry a lot of weight. “The word ‘sufficiently’ is important because that tells us they think rates are or were too high,” Savoie explains. “If they say ‘inflation is too high’ then we know that they think there maybe hasn’t been enough progress.”

Consider tone

It’s not just what they say that matters, it’s also how they say it. Savoie never misses a press conference, even if he can read a transcript later. That’s because the way Macklem, Powell or the other Fed governors and BoC deputy governors emphasize certain words matter. They might talk about risks to upside inflation with a little more oomph than previously or they may downplay risks using a different tone of voice.

“The announcement outlines what they’re doing – that’s an objective statement, but the press conference gives you a tone that accompanies that statement,” says Savoie. “It’s so subtle from press conference to press conference, but it’s really important.”

He also tunes into the Q&A session that happens after an announcement. It’s valuable, he says, because it’s not scripted. In many cases, reporters will press central bankers on different scenarios and whether they’d be prepared to raise rates if something unexpected happens. “You can listen to that to see what the key questions people are asking. These reporters try to dig deep into the thinking behind the statement,” explains Savoie.

What opportunities match with words?

You might feel like a private eye or an investigative journalist trying to decipher the words and tone of central bankers, but in many cases, these officials are far more direct. Earlier this year, BoC deputy governor Paul Beaudry said, “I wouldn’t see the potential rate cuts until probably the July decision.” Yet, markets were still predicting rate drops in the first half of the year. Savoie says that even with all this information investors don’t always believe what they’re hearing or reading. “That’s an unwise thing to do,” he says about not listening to central bankers.

The point of paying attention is to form an idea as to where things might go from here, he explains. As an investment strategist, he’s trying to see if where rates are heading is matching up to what the market is thinking. A mismatch could cause mispricing in some areas or opportunities that he and his team at RBC can then jump on. Any investor can make moves like they do, too.

“The market has become so macro-driven to the point where central banks have a huge influence over the market,” he says. “If you're playing paying close attention, you can spot turning points in the central bank's thinking or their actions which ultimately drive big changes in the markets.”