The Fed’s forward guidance: How it affects monetary policy and markets
How do traders decode the Fed's messaging to anticipate market shifts? In this article, trading expert Michael Stark explores how the Fed’s forward guidance shapes monetary policy and market expectations, offering practical insights for navigating volatile conditions.
Over the last several years, amid high inflation in many countries, monetary policy has been a topic of particular focus for most traders. There’s never a situation when monetary policy is irrelevant, but speculation on upcoming moves, especially by the Fed, has been particularly important since late 2022. This is when participants viewed central banks as walking the tightrope between throttling economic growth with high rates and cutting too quickly, only to see a resurgence of inflation. The Fed’s forward guidance is one of the main ways traders try to predict how rates will change.
In the most recent episode of Trading Talks, the first in a series of podcasts on central banks and monetary policy, we discussed forward guidance, analyzed how to interpret it and compare it with other sources, and gave some examples of how it's worked in the past. In this article, I'll examine how forward guidance is used and the potential limitations in more detail. If you've not heard the podcast yet, here's a summary and link to the video.
Key takeaways
- The Fed's dot plot is the most relevant example of forward guidance used in CFD trading and is usually released at the end of each quarter. The Fed's statement after each meeting also serves, to varying degrees, as guidance.
- The dot plot shows each member of the FOMC's projection for rates at different times in the future. The majority of the dots usually indicate the most likely result.
- Traders often compare CME FedWatch with the latest dot plot. CME FedWatch presents probabilities as percentages of different scenarios at upcoming Fed meetings.
- In some situations, changing data can invalidate forward guidance, such as inflation. In such a scenario, CME FedWatch will react much quicker than the dot plot.
- Gold’s strength in 2025 so far is significantly, but not exclusively, the result of the Fed’s declining dovish expectations.
Forward guidance and its role in monetary policy
As noted in the podcast, the main reason forward guidance (like the Fed’s forward guidance) moves markets is because that’s what it’s meant to do. The Fed and other central banks use forward guidance specifically to set realistic expectations among all relevant market participants. In practice, this means that uncertainty and volatility are lower than they would be without it. The Fed doesn’t like to surprise traders, except in genuinely extreme circumstances.
Before 1994, the Fed never announced its decision after each meeting. This meant that market participants had to guess whether and how policy had changed by monitoring open market operations afterwards, essentially ‘backward guidance’. From 1994 onward, the Fed began announcing its decision. Following the dotcom bust, when it became clear that rates would have to rise sooner or later, the Fed became eager to avoid the volatility that might come from surprising participants. They then began foreshadowing their plans in statements from around 2004. You can find specific, relevant examples of this later in this article.
In 2012, it appeared that the worst of the economic fallout from the global financial crisis was over, and rates would need to rise within the next few years. Then the Fed launched the dot plot to make forward guidance clearer and more transparent.
This dot plot from June 2025, the latest available at the time of writing, plots each member of the FOMC's expectations for rates at the end of each upcoming year. Each dot represents what one senior central banker thinks the funds rate will be at the end of the year, listed on the lower scale. Most of the time, dots fall between two specific numbers, indicating a range between them. In this scenario, ‘Longer run’ means where the funds rate might stabilize without significant economic shocks.
In simple terms, the Fed expects participants to use the average of all the columns to determine their policy expectations at the end of the relevant year, something that has become general practice among most parties. For example, the dot plot above suggests a funds rate in the range of 3.75–4% at the end of 2025, which, as of July, seems likely based on other sources of information as well.
This is useful for the Fed because it gives every relevant party a reasonably good guide (though not a specific prediction) of what the rate might be in several months, allowing them to plan accordingly. For example, businesses might expand hiring and operations when rates are expected to come down, but do the opposite when the dots suggest tighter policy. This is what the Fed wants because it usually allows the central bank to see the effects of its policies much faster. It also helps prevent the frantic scramble to react to fresh decisions that might occur when no one knows what to expect.
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How central banks use communication as a policy tool
During his tenure as head of the ECB's Executive Board, Mario Draghi was asked directly during the press conference following each meeting about exchange rates on several occasions. His answer was along the lines of, "Wow, it's 1.23 USD? Imagine that, golly gosh. Anyway, that's not my problem. Next question." I imagined traders collectively rolling their eyes at the ridiculous notion that Dr Draghi wasn't actively monitoring all relevant markets in the runup to a meeting and press conference.
I think the critical point here is that it’s often not what a central banker says that influences markets, but how and when they say it. In this regard, there’s a strong element of political and rhetorical skill involved in running a central bank. Above all, central banks try to project an air of confidence and professionalism in their communications. That’s a big part of the reason they tend to use jargon in statements and verbal comments when simpler layman’s terms would often do instead.
The Fed’s Chairman, Jerome Powell, has built a reputation for trying to keep markets calm during his press conferences—a pattern he has followed consistently throughout most of his tenure. Dr Powell almost always uses a neutral tone to the point of monotony in press conferences. He avoids raising his voice, displaying emotion, or gesticulating as a politician often might. When asked any question with even a slight political hint, he states facts almost robotically and avoids giving any hint of his personal opinion on the matter. This approach usually works very well to calm markets and prevent his press conferences from turning political or theatrical.
Key phrases and markets’ reactions to them
After their meeting, a central bank's statement usually follows a set formula and doesn't change much from issue to issue. Over the years, there has been a long list of recurrent words and phrases in statements, and here's what I think about some of the most important recent ones.
“Transitory inflation”
Possibly the most widely recognised specific phrase from the Fed’s statements. On the surface, the meaning is clear: “We think it’s going to come down soon (without us doing much, if anything, about it)”. This phrase was used repeatedly in the Fed’s statements in 2021 and by officials in Joe Biden’s administration. When the ‘transitory’ part was removed in December 2021 and the statement was significantly changed to offer more detail regarding high inflation, participants rightly inferred that the Fed was preparing to hike rates within the next few months.
“Inflation is somewhat elevated”
This and its variations are a favourite phrase from late 2024 and early 2025. Again, the meaning, at face value, is clear: “We think inflation’s too high, so forget about us cutting rates a lot anytime soon.” This signalled that expected further cuts to rates in summer 2025 would probably be pushed back.
“Although swings in net exports have affected the data…”
This term was used in both statements from the second quarter of 2025, and could be interpreted as, "We don't really know yet how tariffs are going to affect the economy. So, we want to play it safe and do nothing for now."
“[...] The Committee is attentive to the risks to both sides of its dual mandate.”
This sentence, sometimes with qualifications, was used in all four statements in the first half of 2025 and could be translated as, “None of the main economic indicators show very clear trends. So, we want to watch upcoming releases to see what to do next, and we’re not going to rush into doing anything reckless.”
Case study: How historical forward guidance has moved markets
For me, the most prominent recent influence of forward guidance on markets was the significantly greater clarity it provided regarding the dovish move between December 2023 and March 2024’s dot plots:
On the face of it, the outlook for rates didn’t change much between the two dot plots. However, there was a clearer majority expecting 4.5-5% by the end of 2024 and 3.5-4% by the end of 2025. Participants had more confidence in an extended cycle of loosening, even though, at the time, a resurgence of inflation seemed more likely than it does now. Gold soared in the aftermath, entering a sustained uptrend on the weekly chart with a peak in April 2025.
I want to stress here that forward guidance isn’t the be-all and end-all. Every forex pair with the dollar usually moves strongly based on what the other central bank is doing, both in isolation and relative to the Fed, and economic and political factors. Meanwhile, gold remains the most important of the three traditional havens and is further influenced by supply and demand. I never use forward guidance exclusively to find the rationale for a trade, but I combine it with various other factors.
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Final thoughts: Using Fed forward guidance in your monetary policy strategy
I believe that, most of the time, it’s not necessary to read the Fed’s full statement in detail or watch all of the press conference, and do some kind of rhetorical analysis of the choice of words or structure. When I first started trading in line with central bank meetings and press conferences, I practiced speed reading and passive listening. I kept specific words and phrases in my head like ‘inflation’, ‘labour market’, ‘trajectory’, and similar, tuning in with full focus only on these most relevant sections.
I also believe that forward guidance can be critically important for any trader, not just swing and position traders. Scalpers and daytraders can actually find excellent opportunities for gold trading and forex trading in particular, if they speedread the Fed’s statements and dot plots, and manage to find the key changes quickly. This allows you to find a reliable early entry to a new movement, assuming other factors align.
Understanding Fed forward guidance is essential for staying ahead of monetary policy shifts that move markets.
Trading fresh forward guidance has never been better than with Exness. Even around the most important news like the Fed’s statement and press conference, Exness’ spreads for gold are four times better than the average offered by other major brokers. Fund your account and prepare for the next sudden movement.
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