Markets head into the first Fed meeting under new Chairman Kevin Warsh with little knowledge of what he thinks about the recent surge in employment, accelerating inflation and the direction of interest rates.
And that may be by design.
Mr. Warsh has been a strong critic of the Fed’s communications, saying it leads to policy errors and puts the Fed more central to market decision-making and the economy than necessary. His “regime change” plan includes rethinking how the Fed predicts and talks about its monetary policy plans. This seems to include both quantity and frequency.
“If you ask me what my real personal opinion is at this point, the Fed chair and other central bankers around the FOMC have been speaking quite often,” Warsh said during his confirmation hearing in April, referring to the Federal Open Market Committee. “Let me just say this: I think the pursuit of truth is more important than repetition. If you’re going to hold a press conference, you want to convey important news.”
The immediate short-term question is where Warsh stands on the issue of removing signals from the Fed’s policy statement to markets that it wants to continue lowering rates. “Easing bias” is part of the FOMC statement that suggests further rate cuts. At its last meeting, three FOMC members voted against it, calling for the Fed to stop its tendency to cut interest rates.
And so-called Fed statements, where every word is analyzed by the market, may be even more nuanced.
Michael Feroli, chief economist at JPMorgan, said he didn’t think Mr. Warsh would say he was “open” to raising rates, “but he clearly says he can’t rule out a rate hike.”
Eliminating the easing bias would be consistent with Mr. Warsh’s long-term desire to reduce how the Fed communicates its next actions.
In 2014, after retiring early in his term as Fed director, Warsh led an internal review of the Bank of England’s communications strategy, generally advocating for more transparency but less overall communication. He said the BOE’s monthly meeting schedule is “suboptimal” and recommended reducing the number of annual meetings from 12 to eight.
“Excluding periods of crisis, economic conditions tend to change fairly slowly. In practice, it is rare for an economy to change rapidly enough to require adjustments in monetary policy every four weeks,” Warsh said in the report.
Just last year, Mr. Warsh echoed this sentiment in a speech at the Hoover Institution, saying, “Fed leaders would rightly skip an opportunity to share their latest thinking…The swivel chair problem, rhetorically waxing and waning with the release of the latest data, is common and counterproductive.”
The Fed has already announced that Mr. Warsh will hold a press conference after next week’s meeting, suggesting that, at least initially, it is adhering to the practice of immediate past Fed Chairman Jerome Powell. But in Senate testimony, he did not commit to holding a conference after each session. This has led to speculation that Mr. Powell will return to the same four-a-year schedule he held before increasing the frequency of each meeting.
But there are also potential costs, including increased market volatility and loss of power for the Fed chair.
“It’s not a very good idea for the Fed to surprise markets (or) backtrack on communication,” said former Cleveland Fed President Loretta Mester. “But that doesn’t mean it can’t get better.”
Former Fed Vice Chairman Richard Clarida warned soon after Warsh was appointed in January that “the transition to a new communications structure may be difficult.”
Mr. Warsh would best like to see the Fed make policy decisions through robust discussion around the table, rather than the Fed chair rallying FOMC members together to make decisions before the meeting. He believes this will lead to better decisions and better meetings.
Mr. Warsh’s problem is that he has little control over his colleagues’ public speeches and interviews. The 12 district Fed presidents have an independent voice and often use that right before and after meetings.
“You can’t move to a world where no one talks about it,” Clarida told CNBC. “People will speak. It makes sense not to abandon the bully pulpit.”
This is also an argument for continuing to hold press conferences at every meeting.
“The press conference is the chairman’s best friend,” Feroli said. “This allows the chair to set the narrative from the beginning about what happened at the meeting and what the committee is thinking now.”
For Warsh, the benefit of providing less guidance about the Fed’s future direction would be that he would be less influenced by what the Fed says and would have better signals from the market about where the Fed should go.
In 2004, former Fed Chairman and then-Government Governor Ben Bernanke coined the term “the hall of mirrors problem… where policymakers are simultaneously trying to send signals to markets and gain insights from markets about future policy.”
Warsh believes that Fed communications taint that signal by over-guiding markets to expectations that Fed officials feel obligated to fulfill, even if it is the wrong policy.
He has made similar criticisms of the “dot plot,” in which officials anonymously write down their predictions for the federal funds rate. He believes this has prevented the Fed from acting quickly to curb inflation caused by the coronavirus pandemic.
“The Fed is telling the whole world what the points and expectations are going to be,” Warsh said in Senate testimony in April. “Well, the Fed is human, too, so it holds on to its forecasts longer than necessary. Even if the Fed waits until it meets before making a decision, I think its incremental deliberations will prevent the central bank’s errors from becoming even more widespread.”
Former St. Louis Fed President James Bullard said several ideas are being discussed within the Fed to solve the “dot plot” problem. That includes issuing forecasts at some point after the meeting to keep the market’s attention on this statement. Another idea is to publish staff forecasts verbatim, but staffers themselves have resisted the idea because they fear it could be subject to political scrutiny.
This forecast document is determined by the entire FOMC, meaning it cannot be changed unilaterally by Mr. Warsh. This confirms the general expectation that the new Fed chair is planning major changes to the Fed’s communications strategy, but they are likely to occur only gradually.
