Financial Markets' Perceptions of the FOMC's Data-Dependent Monetary Policy

Abstract

Over the past ten years, the Federal Open Market Committee (FOMC) has repeatedly emphasized that future policy is data dependent. In this Economic Commentary, we investigate how financial markets expected future interest rates to change with the release of new data on inflation and labor market conditions. We find that the surprises in economic indicators have a stronger effect on the 2-year Treasury yield than on the expected federal funds rate to be set in the next FOMC meeting. This implies that markets understand that under the data-dependent approach, policy decisions do not heavily rely on the most recent data or short-run fluctuations, but, rather, rely more on the persistent trend of the economy. In addition, we observe that expected future interest rates have become more sensitive to surprises in inflation after 2022, suggesting that the FOMC's determination to reduce inflation has been well-understood by the markets.