Who Holds the Levers
The Federal Reserve’s new chair, Kevin Warsh, moved quickly Wednesday to reduce the central bank’s communications, cutting the statement on its interest-rate decision to 132 words from 341 in April and removing any hints, or “forward guidance,” about the Fed’s next moves. The shift hands more uncertainty to markets, workers, borrowers, and businesses while the central bank keeps the power to move rates and shape the economy from above.
Warsh said the Fed will set up five task forces to examine its communications, balance sheet, how it analyzes and gathers economic data, the impact of AI on productivity and jobs, and the frameworks it uses to analyze inflation. He said at Wednesday’s news conference, “Financial market prices are probably the most important source of information to guide central bankers.”
Who Pays for the Guesswork
Analysts said Warsh’s approach could lead to more violent swings in stock and bond prices and ultimately higher interest rates for consumers and businesses. George Pearkes, global macro strategist at Bespoke Investment Group, said, “Forward guidance in general has served to suppress volatility and anchor market expectations,” and added, “And that has led to lower borrowing rates, relative to alternatives.” Pearkes said the impact on consumers is likely to be modest, with mortgage rates perhaps a quarter-point higher than they would be otherwise.
Financial markets see-sawed and then fell Wednesday after the statement and news conference. The yield on the 10-year Treasury, which strongly influences mortgage rates, jumped Wednesday to 4.49% from 4.43%, though it fell back in Thursday trading. The yield on the 2-year Treasury, which closely tracks expectations for Fed action, was 4.16% Thursday, up sharply from 4.05% before the Fed’s meeting. The broad S&P 500 stock index dropped 1.2% Wednesday.
Warsh said the communications task force would consider changes to the quarterly economic projections the Fed issues as well as other recent innovations, including press conferences. Former chair Ben Bernanke was the first to hold them, though he did so only after every other Fed meeting. Warsh’s predecessor, Jerome Powell, shifted to holding them after every meeting.
What the Central Bank Is Reversing
Warsh has frequently cited former chair Alan Greenspan as a model. Greenspan, who served as chair from 1987 to 2005, did usher in the statement the Fed now issues after each meeting announcing its decision. The first statement was issued Feb. 4, 1994, and said the Fed would increase its key rate for the first time in five years. The move caught investors off-guard and the Dow Jones Industrial Average plunged 2.4% that day.
Matthew Luzzetti, chief U.S. economist at Deutsche Bank, said, “This is a big change in how the Fed has conducted itself since the (2008-2009) global financial crisis.” He added, “Since then there has been a one-way train to greater communication, more transparency, and more forward guidance. Warsh has now put that train in reverse.”
Previous Fed chairs, starting with Bernanke, have seen a clear benefit to more communication because it helps guide markets in the direction the Fed wants. Fed officials control a short-term interest rate, but the rates that affect the economy, such as the yield on the 10-year Treasury, are heavily influenced by investors’ expectations for inflation and economic growth. By telegraphing their next moves, policymakers can cause those longer-term rates to change even before the Fed adjusts its own benchmark rate.
Warsh’s decision strips away some of that signaling and leaves investors to read the tea leaves themselves. He wants investors to gauge where the Fed may move next by examining economic data and making their own judgments, which the Fed can then consider as part of its assessments of where the economy is headed.
David Andolfatto, an economics professor at the University of Miami and former economist at the St. Louis Fed, said forward guidance has flaws and can be easily upended by unexpected events such as Russia’s invasion of Ukraine or the Iran war. He said the chair should set out guidelines for how the Fed will react to unexpected events or to challenges such as the persistent inflation it is grappling with now, but said Warsh so far hasn’t done so. Andolfatto said, “I’m with him on dispensing with forward guidance, but you have to replace it with a contingency plan.” He added, “It’s not enough to say, trust me, we’ll keep inflation at target.”
Pearkes said Warsh’s decision to drop forward guidance may empower the other 18 members of the Fed’s rate-setting committee, who frequently give public speeches and whose remarks will get even more attention as financial markets seek clues about what the Fed may do next. Pearkes also said a big challenge to Warsh’s approach will come if there is a sharp financial downturn or economic crisis, as occurred during the COVID pandemic, because forward guidance can play an important role calming markets in those circumstances.