Economist Writing Every Day

Under Jerome Powell, a typical FOMC meeting had become almost a market event in itself. Traders didn’t just care about the rate decision. They dissected every word of the statement, every sentence of the press conference, and especially the “dot plot,” looking for clues about where rates might be six months or a year from now. The Fed wasn’t simply setting monetary policy—it was guiding expectations. Markets often moved as much on hints about future decisions as on the decision itself.

The first two FOMC meetings under Kevin Warsh have felt very different. The dot plots are gone. Forward guidance has largely disappeared. Instead of trying to signal the likely path of policy, Warsh has repeatedly stressed that the Fed will respond to incoming data when it arrives, not commit itself to forecasts that could prove wrong. At his latest press conference, he described avoiding forward guidance as “prudent” given current uncertainty, while reminding reporters that “There is no soft or alternative inflation target—only 2%.”

This is a huge change in communication style, which is having real world consequences.

Warsh long argued that forward guidance can box policymakers into decisions based on yesterday’s forecasts instead of tomorrow’s realities. That is, once their tentative plans had been put out in public, there was a psychological bias among Fed members to lock in on those projections, which would inhibit their ability to rationally interact with the most recent data and situation. So now, rather than telling markets what the Fed expects to do, he wants investors to make decisions based on fundamental economic conditions, knowing that the central bank will react only after the facts justify it. At the latest FOMC meeting he said, “Market participants are learning to play the ball, not the referee—and market prices will continue to respond in the direction and magnitude they see fit. This is, in my view, a change for the better—and we are just getting started.”

That approach chips away at what investors have come to call the “Fed Put”—the belief, built up since the 2008 financial crisis, that the central bank will fairly quickly and forcefully step in to support markets whenever things get rough.

If that belief fades, financiers may think twice before taking excessive risks. Leverage becomes more dangerous if there is less confidence that easier monetary policy will quickly arrive to cushion losses. Risk premiums may better reflect actual economic uncertainty rather than expectations of future Fed support. That is the possible good side of Warsh’s more hands-off approach. Ideally, business people will exercise more prudence on their own, lessening the odds of financial catastrophes that would require Fed intervention.

On the other hand, markets hate uncertainty, and less guidance means more volatility around Fed meetings. I think Powell tried to use sheer talking (jaw-boning) as a tool to influence market rates, lessening the need for the Fed to actually employ its blunt instruments there. Warsh seems to have taken that tool off the table.

Also, I think some (not all) the causation for the rise in 30-year Treasury bonds to twenty-year highs, and of home mortgage rates to one-year highs accrues to Warsh. First, by eliminating dot plots and forward guidance, he has increased uncertainty about the future path of policy. Investors can no longer confidently assume the Fed will ease at the first sign of economic weakness. That uncertainty can raise the term premium, pushing long-term yields higher.

Second, if markets believe the “Fed Put” is weaker, they may demand higher yields to hold long-term bonds because they perceive less protection from adverse economic or financial shocks. In other words, investors require more compensation for risk.

Whether today’s higher long-term rates are a healthy reflection of economic realities, or an unhealth drag on growth, is a matter of debate.