Why the Fed’s Words Move Markets

Not so long ago, the Federal Reserve said very little about its policies.

“Central banks used to hide their deliberations from public view more jealously than the papal conclave,” the Financial Times quipped.

Those days are behind us.

With minutes, “dot plots” every quarter, and press conferences after every Federal Open Market Committee meeting, transparency is far greater than it was before the 2007-2008 Global Financial Crisis.

But one thing remains the same: financial markets hang on the Fed’s every word, and billions of dollars in profits and losses ride on the meaning of every carefully chosen word or phrase.

Subtle single-word changes, such as saying “monitoring” inflation rather than “addressing” inflation, become an exercise in reading the tea leaves.

“We live in a world where every word coming from the Fed is being parsed — every word said but also every word left unsaid,” says Bo Sun, an associate professor of business administration in the global economies and markets area at the University of Virginia's Darden School of Business.

That’s because what the Fed says doesn’t just convey information about the central bank’s plans — it also sends a signal that influences how millions of people will behave.

“Investors not only interpret the remarks but try to guess how other investors will interpret the remarks,” says Steven Pinker, a professor of psychology at Harvard. In that regard, the words “are like an oath or a pronouncement of a jury verdict or marriage ceremony, or a prayer or a magical incantation — the mere act of uttering them changes the world.”

This is why Sun, who spent a decade as an economist at the Federal Reserve Board, believes it’s essential that Darden students learn how Fed watchers and financial markets interpret and respond to the signals from one of the most important players in global finance. 

To do that, she has written two new cases: Decoding Fedspeak and Interpreting Fed Communications in Uncertain Times. Together, they offer two lenses: one on the Fed’s communication toolkit and how it has evolved, and one on how markets react.

The pair will be used in a module on policymaking under uncertainty, part of the second-year elective “Managing Economic Uncertainty” offered in the fall.

Learning to Listen

“The Fed is one of the most economically powerful policymaking institutions,” says Sun. “Given the economic juncture we face, it’s particularly important to develop a solid understanding of how the Fed has been thinking about how to best communicate policy.”

Sun says understanding the signal embedded in Fedspeak is highly valuable, not just for students going into investment banking, but also for those considering consulting, corporate finance and other careers.

“There is a lot of value in being able to understand in real time what the central bank is communicating — the nuances, signals, and how those messages ripple through financial markets. The Fed sits at the nexus of financial markets and broader economic policy,” says Sun.

The Power of the Fed

The Fed is central to the U.S. economy — it sets the stance of monetary policy to achieve its dual mandate of price stability and maximum employment.

“U.S. monetary policy is a primary stabilization tool,” Sun explains. “The economy goes through ups and downs, or business cycles — recessions versus booms — and by lowering interest rates to stimulate investment and economic activity, or, doing the opposite — raising interest rates, which exerts a dampening effect on economic activity — monetary policy, together with fiscal policy, is a key instrument to stabilize the economy.”

The primary stabilization tool for monetary policy today is adjusting the target range for the federal funds rate, which is the interest rate at which commercial banks lend their excess reserves to other banks overnight. 

Changes in the Fed’s actual and expected policy stance cascade through the economy, affecting everything from short- and long-term interest rates — from mortgages to business loans — to overall borrowing costs.

Lower rates make borrowing cheaper, encouraging spending and investment, while higher rates dampen these activities. By influencing borrowing costs, the Fed can stimulate economic growth during downturns or combat inflation. 

What the Fed communicates, even on days when there is no policy rate change, affects markets’ perception of not only the direction of future policy but also, importantly, expectations of inflation and economic growth.

Long-term interest rates and, thus, most borrowing costs, depend importantly on inflation. The market interpreting what Fedspeak reveals about the U.S. economy can be part of how the Fed affects the economy.

When Every Word Counts

On Aug. 22, Fed Chair Jerome Powell delivered a closely watched speech at the central bank’s annual Jackson Hole gathering. Markets scoured every word for clues about a potential September rate cut.

“The balance of risks appears to be shifting,” Powell said. With borrowing costs weighing on the economy, the labor market softening, and inflation risks contained, “the shifting balance of risks may warrant adjusting our policy stance.”

It was his clearest signal yet that the Fed is preparing to resume rate cuts. Investors, already expecting a September move, reacted with fresh anticipation. Stocks jumped and two-year and 10-year Treasury yields tumbled as markets recalibrated Fed policy expectations.

The remarks also highlighted the art of decoding “Fedspeak.”

Longtime Fed watcher Jon Hilsenrath, a former WSJ journalist and author of Yellen, a biography of the U.S. Treasury Secretary and former Fed leader, flagged this key passage:

"In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside — a challenging situation. … Monetary policy is not on a preset course."

His translation:

“The Fed is in a box. The job market is weakening. Inflation is rising. … Powell thinks he’s got space to move because the benchmark rate, at 4.3%, is relatively high. But he will ‘proceed carefully.’ **Important, intentional phrase overlooked by many people this morning!**”

As Sun notes, while the Fed has become more transparent, the gap between Fed watchers and broader markets endures —  underscoring that decoding Fedspeak is an acquired skill that sets seasoned observers apart and offers real value for MBAs.

This close attention to Powell’s words reflects a broader change in how the Fed communicates — and the reality that not everyone hears the same message — which Sun examines in her teaching cases.

From Whisper to Megaphone

In Decoding Fedspeak, Sun charts the evolution of the central bank’s communication strategies over the past several decades.

When David Wessel, a former reporter at The Wall Street Journal, arrived in Washington, D.C., the Fed operated behind a veil of secrecy.

“The Fed didn’t even announce when it had moved interest rates,” Wessel recalled. “They signaled them by the way they intervened in money markets, and we at The Wall Street Journal had a good thing going because we were able to confirm the Fed’s moves and made our reputation doing that.”

That all changed in 1994, when the FOMC shattered precedent and began issuing statements after meetings. Over the decades, the Fed’s messaging arsenal expanded: post-meeting statements, minutes, the Summary of Economic Projections (with its famous “dot plot”), and regular press conferences.

As Sun writes, “By clearly communicating its policy strategy and consistently following it, the central bank enhances its credibility, which in turn improves its ability to shape expectations and influence the economy.”

For students, the case is about more than the Fed — it’s a lesson in how institutions craft consistent narratives, use credibility as a strategic asset, and manage expectations in uncertain environments.

When Words Trigger Whiplash

But words don’t always calm. In Interpreting Fed Communications in Uncertain Times, students step into the shoes of the head of macro strategy at an investment firm, grappling with moments when Fed communication sparked market volatility.

The case explores how financial markets interpret Fed communications set against two important press conferences: Ben Bernanke’s June 2013 hint that the Fed might begin tapering its massive asset-purchase program later that year (known as the “Taper Tantrum”)  and Jerome Powell’s March 2020 emergency announcement slashing rates to near zero and launching $500 billion in quantitative easing.

One signaled a conditional slowdown in accommodative policy (reducing asset purchases while maintaining low rates). The other announced the start of extraordinary accommodation. And yet, both triggered panic.

“How can markets enter a mode of frenzy after both conditional signals of policy normalization and implementation of extraordinary accommodation” the strategist wonders.

As Sun explains through the case, policy announcements aren’t just about policies — it is possible some market participants extract signals about the Fed’s view of the underlying economy. Markets typically rally when the Fed cuts rates (lower borrowing costs) and fall when rates rise.  However, markets sometimes do the opposite — declining after surprise cuts or rising after unexpected hikes.

Recent economics research studies the latter phenomenon and debates whether the market interprets not just the “what” but the “why” behind Fed decisions: aggressive easing might at times be interpreted by some market participants as reflecting the Fed’s private information about economic weakness.

Students benefit from recognizing the counterintuitive market patterns and developing an understanding of the potential dynamics at play.

Navigating Uncertainty

While the Fed’s goal is to communicate policy paths to the public, today’s environment makes this harder.

“Uncertainty is high,” Sun says. “‘The shocks are of a different nature from what central banks faced in the past, and the impact of the shocks is more uncertain. Forecasting has therefore become much more difficult.”

Recent shocks have ranged from the COVID-19 pandemic and the war in Ukraine to supply chain disruptions, climate risk, digital currencies and tariffs.

“The impact of these shocks is hard to predict, so the central bank is trying not only to figure out how best to incorporate that uncertainty into its decision-making, but also how to communicate that uncertainty to the public,” Sun says.

For students, that means deciphering Fed communications requires deliberate skill-building that evolves as the Fed’s communication strategies shift in real time, an essential skill to lead in a world where words can move markets as powerfully as deeds.

Professor Bo Sun is the author of the cases “Decoding Fedspeak” and “Interpreting Fed Communications in Uncertain Times,” published by Darden Business Publishing (2025).