The Fed has to move away from two concepts at tomorrow's post-FOMC briefing if it wants to address the markets' concerns -- forward guidance and neutral funds rate. While both concepts may have helped when the Fed was beginning to normalize policy, sending the message that rates would stay low for a long time, they now appear to lead market participants to believe the Fed is on a predetermined course to raise rates. While Powell may give lip service to them, he should emphasize the Fed will be ready to move in either direction at any FOMC meeting if the data or circumstances require. Opening the door to cutting rates should be a big positive for stocks.
A major problem with forward guidance is that it could be self-fulfilling by reinforcing market expectations. For example, if the Fed lowers its GDP forecast in its Central Tendencies, the bearish economic view in the market would get a boost and hurt stocks. A further drop in stocks would be a negative for the economic outlook. Moreover, a weaker Fed GDP forecast could persuade companies to pull back from investment and hiring. Bernanke and Paulson fell into that trap in September 2008 when they appeared on TV to say the US was heading to the worst recession ever (they were trying to sell TARP to Congress). Massive layoffs occurred right afterwards.
A major problem with the concept of a neutral funds rate is that it is a feature of what economists call a "steady state" long-run path of the economy. The economy is assumed to be growing at a constant rate, with no effect from "exogenous" factors or initial conditions. In the real world, exogenous factors and initial conditions matter. So, by targeting an unobservable, estimated neutral rate, the Fed could be ignoring important information. At the moment, the stock market is focused on the exogenous -- weakening foreign economic growth, government shutdown possibility, and trade negotiations.
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