Losing the plot? Warsh's Fed more 'touchy-feely' than data-driven: Mike Dolan

While keen to assess how policy is bearing on the economy, Warsh clearly doesn't want to rely on models or any structure that nails him down to a course of action. Hyper-dependence on data, too, seems to have been pushed aside in favor of gauging the speed and trend of inflation "convergence" rather than forensically examining a single month's reading. "We see the lack of forward guidance and Warsh’s dismissiveness of the longer run dot as encouraging an upward drift in rates, something we anticipated would be the result of rejecting the dovish anchors for policy expectations," wrote SGH Macro Advisors economist Tim Duy. The upshot for many is that Warsh is trying to move to a situation where the policy assessment is more about assessing the look and feel of the economy at the moment and going forward, rather than bolting in absolutes and parameters. "This increasingly looks like a new regime, and a bigger break from the past than appreciated," said UBS economist Jonathan Pingle. Even if this "new regime" proves more effective, it will leave many more deep splits among markets and investors over the months and years ahead. The Federal Reserve's first interest rate rise in three years somehow surprised many investors, despite futures markets having priced it in well before. Yet that sort of disconnect and second-guessing is exactly what new Chair Kevin Warsh has encouraged — and his press conference suggested precision forecasting may be out of vogue. On one level, last week's quarter-point rate rise had been built into futures market pricing ever since Warsh's keynote speech at the annual Jackson Hole conference in August, and its probability was cemented at about 90% after the August consumer and producer price inflation reports failed to show sufficient progress toward the Fed's 2% target. But don't assume that the unanimity declared by Fed policymakers, or the confident futures pricing, was matched in the broader investment community. As one example, Bank of America's closely watched monthly survey of global fund managers — based on responses from about 170 asset managers collectively steering about half a trillion dollars — showed that more than half of respondents polled from September 4 to 10 still saw no Fed rate rise before November's midterm elections. To be sure, this was well below the prior month's reading of 75% who thought as much, but it's still remarkable that some 52% saw no policy move just a week or so before the rate decision. Given that Warsh has been explicit about his disdain for so-called forward guidance — insisting markets should make up their own minds rather than being guided by fixed Fed commitments over the horizon — he may well welcome that sort of split thinking for keeping everyone on their toes. He may be less comforted by the fact that some of that thinking may have assumed that he and others on the Fed would buckle under political pressure to hold rates steady. Regaining credibility in his independence may have been one key rationale for pushing for the hike. And as he awaits the outcome of his five task forces on Fed reforms, Warsh's own way of sidestepping guidance in the interim has been to refrain from posting a forecast in the Fed's quarterly "dot plot" of economic and policy rate projections. That's more of a token gesture, as the rest of the Federal Open Market Committee (FOMC) continues to fill in the form for now. The big takeaway from last week's update was that the median of Fed policymakers doesn't now see core personal consumption expenditures inflation returning to the central bank's 2% target until 2029, while the median forecast sees another rate rise by year-end. How all of that's sequenced and justified is another matter, and how markets read the shifting sands grows even more uncertain if Warsh succeeds in removing the dot plot altogether. So what will investors look for in the Fed's "reaction function" from here? Another lodestar for rates markets has been the theoretical concept of a so-called neutral rate, where the economy is in balance and monetary policy is neither a drag nor a spur to inflation. By identifying that, the Fed could judge whether its policy-rate level is restrictive or stimulative, and weigh that against the incoming economic data. Despite wide disagreements over estimates of the neutral rate and the models used to derive them, the Fed's own long-term policy-rate projections have often been seen as a proxy for it. Last week, the median estimate of the long-run neutral rate nudged to its highest level in 10 years, at 3.2%, suggesting that the new Fed policy-rate midpoint of 3.875% is quite tight. Futures markets already see three more hikes by mid-2027. Yet Warsh's press conference last week quashed suggestions that the neutral rate or the long-term dot plot estimates are material to policymaking from meeting to meeting. At Jackson Hole and again last week, he made it clear that the existing policy stance showed no sign of restraining credit or the wider economy and could no longer be considered restrictive. While Warsh told reporters he'd always been interested in the neutral rate concept as an academic exercise and that it helps policy discussion, he then set it aside. "Do I think it has any operational effect on decisions that we make today? No, I don't." What's more, he talked of the rate hike as removing a "dose of accommodation" — suggesting he doesn't see 3.875% rates as neutral yet.

Losing the plot? Warsh's Fed more 'touchy-feely' than data-driven: Mike Dolan

Data dependence and investor response

Fed rate hike and market expectations

Neutral rate, dot plot and policy regime

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