Markets go into the first Fed meeting chaired by new Chairman Kevin Warsh probably not knowing what to think about the recent increase in job growth, the acceleration of inflation or the path of interest rates.
And that may be by design.
Warsh has been highly critical of the Fed’s communications, saying they have led to policy mistakes and put the Fed more at the center of market and economic decisions than it should be. His “regime change” plans include rethinking the way the Fed predicts and communicates its monetary policy plans. That seems to include both quantity and frequency.
“If you ask me my real opinion right now, the Fed chairs and other bankers around the FOMC, they’re talking all the time,” Warsh said at his confirmation hearing in April, referring to the Federal Open Market Committee. “I can say this, I think that seeking the truth is more important than repeating. When someone has a press conference, he wants to deliver important news.”
The immediate short-term question is where Warsh stands on the issue of removing the signal from the Fed’s policy statement in the markets that the central bank hopes to keep reducing rates. “Easy bias” is part of the FOMC’s statement that indicates further rate cuts. Three FOMC members opposed the last meeting, indicating that they want the Fed to stop relying on cuts.
And the so-called Fed talk, where all the words are divided by the markets, may be even trickier.
JP Morgan chief economist Michael Feroli doesn’t think Warsh will say he’s “open” to rate hikes, “but I’ve seen him say he can’t pull it off.”
Removing the easing bias would be consistent with Warsh’s long-term ambitions for the Fed to reduce how much it telegraphs its next move.
In 2014, after leaving a previous term as Fed governor, Warsh led an internal review of the Bank of England’s communications strategy and generally argued for less transparency but less communication overall. He called the BOE’s monthly meeting schedule “sub-optimal” and recommended reducing their annual number from 12 to eight.
“Except in times of crisis, economic conditions tend to change very slowly. It is not uncommon for the economy to change so quickly that monetary policy adjustments are necessary at four-week intervals,” Warsh wrote in the report.
Just last year, Warsh echoed those sentiments in a speech at the Hoover Institute, saying, “Fed leaders would be well-served to skip opportunities to share their latest musings…
The Fed has already announced that Warsh will hold a press conference after the meeting next week, suggesting at least an initial adherence to Fed Chairman Jerome Powell’s policies. But, in his Senate testimony, he would not commit to holding them after every meeting. That led to speculation that he might return to holding it four times a year, the same frequency before Powell put them in every meeting.
But there are potential costs, including greater volatility in markets and a loss of power for the Fed chairman.
“It’s not really a good idea for the Fed to surprise the markets [or] going back in terms of communications,” said former Cleveland Fed President Loretta Mester. “But that doesn’t mean it can’t be improved.”
Former Fed Vice Chairman Richard Clarida warned shortly after Warsh’s appointment in January that “the transition to a new telecommunications regime could be difficult.”
Rather than having the Fed chairman involve FOMC members in a decision before the meeting, Warsh wants the Fed to decide policy through a robust debate at the table. He believes this will lead to better decisions and better meetings.
Warsh’s problem is that he has little control over the public discourse and discussions of his colleagues. The Fed’s 12 regional bank presidents have independent speaking privileges and often avail themselves of them before and after meetings.
“You can’t move into a world where no one is talking,” Clarida told CNBC. “People will speak. It makes sense not to give up the bully’s pulpit.”
That is also an argument for continuing to hold a press conference at every meeting.
“The press conference is the chairman’s best friend,” Feroli said. “It allows the chairman to be the first out of the gate to put the story of what happened at the meeting and what the committee is thinking now.”
For Warsh, the sideline of giving less guidance about where the Fed is going would be a better signal from the markets about where the Fed should be going, less influenced by Fed speak.
In 2004, former Fed Chairman Ben Bernanke, then governor, coined the phrase “the hall of mirrors problem … where the policymaker sends signals to the market about future policy and tries to get information from the market.”
Warsh believes the Fed’s communication is contaminating that signal with markets overextending the expectations that Fed officials feel obligated to meet, even if it’s the wrong policy.
He has a similar critique of “dot plot,” where officials anonymously write down their Fed rate forecasts. He believes this has hindered the Fed from acting quickly to curb inflation caused by the covid pandemic.
“The Fed tells the whole world what the rates are going to be, what their forecasts are going to be,” Warsh said in his April Senate testimony. “Well, the Fed is human, and it hangs on to those forecasts for longer than it should. I think if the Fed would wait until it gets into a meeting before making a decision, that increased deliberation would keep the central bank covering up its mistakes.”
Several ideas to fix the “dot-plot” problem have been discussed within the Fed, according to former President of St. Louis Fed James Bullard. It involves issuing forecasts sometime after the meeting, to keep the market’s attention on the statement. Another idea is to simply publish the workers’ forecast, which the workers themselves have resisted due to concerns that it could be viewed as a political issue.
The forecast document is one decided by the full FOMC, meaning Warsh cannot make changes on his own. That underscores the general expectation that the new Fed chairman may plan radical changes to the Fed’s communications strategy, but they are likely to come gradually.
