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Stein sees 'bumps' in markets as Fed gets less precise on policy plan

The Federal Reserve should expect more "bumps in the road" as financial markets react to increasingly less precise communications from the U.S. central bank, a top Fed policymaker said on Tuesday.

In a speech, Fed Governor Jeremy Stein recalled last year's abrupt run-up in market-wide borrowing costs and warned that even the most deliberate communications from the central bank cannot prevent such reactions as the time to tighten monetary policy approaches.

Read MoreWill Yellen take the chill off markets?

"As policy eventually normalizes, guidance will necessarily take a different form; it will be both more qualitative as well as less deterministic," said Stein, who leaves the Fed later this month.

Andrew Harrer | Bloomberg | Getty Images

In part because of "levered bets" among big-money investors, he said, "we may have some further bumps in the road as this all plays out."

The Fed rolled out its latest version of forward guidance in March when it said rates will likely stay near zero for a considerable time after it ends its stimulative bond-buying program. It ditched a reference to a 6.5 percent unemployment rate as a threshold for considering a tightening, essentially adopting a more qualitative approach.

The central bank expects to halt its asset purchases later this year and to raise rates some time next year. The changes will represent a reversal of the most accommodative U.S. monetary policy ever.

Read MoreHere's what changed in latest Fed statement

Addressing a question on rates from an audience of bond traders, Stein said weaker U.S. productivity and potential growth could point to a lower average federal funds rate over the medium-term horizon. The fed funds rate is the central bank's primary policy tool, and it has averaged about 4 percent.

Stein, a governor who in two years at the Fed has pushed for policy decisions to more formally consider financial instabilities, said it is unrealistic to expect that "good communication alone can engineer a completely smooth exit from a period of extraordinary policy accommodation."

In the nearer term, though, he said the Fed is well positioned given that the market "almost uniformly" expects policymakers to "continue tapering our purchases in further measured steps over the remainder of this year."

Indeed, yields on 10-year U.S. Treasury notes have remained low, around 2.6 percent over the last few months, suggesting for now that investors and the Fed under Chair Janet Yellen are on the same page. However, those borrowing costs jumped a year ago when then-Chairman Ben Bernanke suggested the Fed could start to trim the bond purchases in coming months.

Read MoreFed won't consider rate raise until October: Fisher

Attempts to overly manage communications to reduce market volatility may prove "self-defeating," Stein added.

"There is always a temptation for the central bank to speak in a whisper, because anything that gets said reverberates so loudly in markets," he said. "But the softer it talks, the more the market leans in to hear better and, thus, the more the whisper gets amplified."

By Reuters

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