A quieter Federal Reserve could mean volatile markets, higher rates
WASHINGTON
The Federal Reserve has for decades moved steadily from a remote, opaque government agency that shared little about what it did or why to a more transparent institution willing to explain how it makes decisions and what it thinks about the economy.
But in his first press conference on June 17, new chair Kevin Warsh began to reverse some of those steps. Warsh, like many economists, thinks the financial markets have become too dependent on Fed guidance, and that such direction is more effective in financial crises or economic downturns.
Warsh quickly made changes: The Fed’s statement on its interest-rate decision was slashed to 132 words, from 341 in April. And Warsh pointedly noted that the statement excluded any hints, or “forward guidance,” about what the Fed’s next moves might be.
In short, Warsh rapidly delivered on a promise to slash the Fed’s communications, particularly the guidance it gives to financial markets about its next interest-rate moves. Yet such an approach carries the risk of more violent swings in stock and bond prices, analysts say, and ultimately could lead to higher interest rates for consumers and businesses.
“Forward guidance in general has served to suppress volatility and anchor market expectations,” said George Pearkes, global macro strategist at Bespoke Investment Group. “And that has led to lower borrowing rates, relative to alternatives.”
Still, the impact on consumers is likely to be modest, Pearkes added, with mortgage rates perhaps a quarter-point higher than they would be otherwise.
Financial markets see-sawed, then fell on June 17 after the statement and news conference. The yield on the 10-year Treasury, which strongly influences mortgage rates, jumped to 4.49 percent from 4.43 percent, though it fell back in June 18 trading. The yield on the 2-year Treasury, which closely tracks expectations for Fed action, was 4.16 percent on June 18, up sharply from 4.05 percent before the Fed’s meeting. The broad S&P 500 stock index dropped 1.2 percent on June 17.
Such swings could be a sign of things to come. Previous chairs have signaled the Fed’s next moves clearly enough that financial markets have largely anticipated the central bank’s actions. But Warsh has frequently cited as a model former chair Alan Greenspan, whose circumspect comments often kept investors guessing.
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 percent that day.
The paring back of Fed communications is part of a larger package of potential reforms to the central bank’s operations that Warsh signaled on June 17. He announced that the Fed will set up five task forces to examine the Fed’s communications, its 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.
Warsh said the communications task force would consider changes to the quarterly economic projections the Fed issues as well as look at 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.
Such steps are a sharp contrast with the 1990s, when Greenspan never explained a Fed decision, on the record, to reporters. Warsh could ultimately dial back some of the Fed’s increased transparency.
“This is a big change in how the Fed has conducted itself since the [2008-2009] global financial crisis,” Matthew Luzzetti, chief U.S. economist at Deutsche Bank, said.
“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.”