Keeping a lid on expectations key to avoiding black swans

What the financial market fears most are black swan events. This refers to the occurrence of something outside of general expectations. The possibility of the event occurring is not believed due to past experience, so it has a big impact.

The emergence of Covid-19, which brought the global economy to a near total halt, is the best example of the black swan effect in recent years.

That is why, by way of preventative measures, central banks and financial officials have, in recent years, focused on expectation management. This is becoming more and more important for governments looking for ways to achieve their goals, especially with regard to central bank interest rates, since this will affect the interest rates of loans, bonds and other financial instruments, which in turn affects economic development and asset price movements.

As a result, since the outbreak of the pandemic, European and American central banks have launched massive rounds of quantitative easing that are much bigger than rounds initiated during the 2008 financial tsunami.

In addition to instantly bringing stability to the global economy, the quantitative easing can also potentially have great consequences, because if central banks tighten monetary policy improperly, this will result in great sequela in financial markets.

So, as the world's most influential central bank, the United States Federal Reserve has been doing a lot of work on expectation management regarding interest rates, such as its schedule on shrinking the debt-purchase scale and raising interest rates.

Jerome Powell, the chairman of the Fed, reveals the intention of the Federal Open Market Committee after each meeting. Almost instantaneously, markets watchers will predict future interest rate activity through the Fed's dot plot. If the Fed cuts its debt purchase scale or raises interest rates, the market absolutely has enough information to make an analysis. The chances of a black swan effect resulting from the Fed's monetary policy are low, which reduces volatility.

Of course, the Fed is not without its mistakes. Shortly after then-Fed Chairman Ben Bernanke took office in 2006, he told CNBC anchor Maria Bartiromo at a dinner that the market had misinterpreted his comments at a congressional hearing that the rate-raising cycle was over.

It turned out that after Bartiromo revealed what she had heard to CNBC, there was instant sharp fluctuations on the US stock market. After that incident, key officials, especially the chairman, have been particularly careful when discussing their views on monetary policy.

The Fed will also articulate clearly the intentions of all officials from the FOMC to the market to avoid misunderstandings that may cause unnecessary volatility.

Investors may wonder whether volatility is inevitable as long as markets continue to rely on quantitative easing, despite central banks' attempts to manage expectations. This is possible, but it could also be the result of a lack of expectation management, since it is not always a "dove" - when appropriate, a "hawk" may fly out.

It might also be a good to take step by step approach when tightening monetary policy to help the market adjust and reduce reliance on central banks. I believe this will help prevent the black swan effect.

Therefore, it is true that the Fed's current monetary policy has created a bubble, but if expectation management is well done and effectively coordinated with monetary tightening, there is a chance the bubble will gradually deflate rather than burst and a crisis can be avoided.

Next week, I will discuss the potential implementation of such policies on the mainland.

Andrew Wong is chairman and CEO of Anli Securities