The slow death of ‘forward guidance’?

Here’s a generous reading of the situation developing in Washington. New Federal Reserve Chair Kevin Warsh, a Donald Trump appointee, has broken the vicious cycle of the markets taking a steer from the US’ central bank. The Fed, in turn, has previously looked at Wall Street before making its own decision on interest rate levels – one of its big levers. 

Warsh, a long-standing Republican who once advised George W. Bush on economic matters, has achieved this by outright refusing to give a flavour of his thinking around the country’s monetary policy. You want Warsh to opine on inflation or interest rates? He will simply tell you that the Fed should be a “good steward” of US taxpayer money. 

It’s a step further towards monk-like silence compared to Alan Greenspan’s infamous mumblings and grumblings around monetary policy, which market commentators dubbed ‘Fedtalk’ and spawned a kind of Kremlinology with financial analysts studying Greenspan’s facial expressions. An eyebrow raise could indicate a hike, a slight smile an indication of a relaxation in rates. 

Ben Bernanke, who succeeded Greenspan in 2006, took the Fed’s communication policy in another direction. He championed the idea of ‘forward guidance’, with the central bank giving an indication of its thinking and where, ultimately, interest rates were going. The policy arguably peaked during the 2008 financial crisis, when a maximalist approach to central bank communication was needed to keep the markets relatively calm. 

But since then, the internet has morphed into Web 2.0 - we now have generative AI and a deluge of financial information flows throughout the world in milliseconds. Add in a geo-macro system which is deeply uncertain, and you can see why Warsh thinks forward guidance is outdated and potentially dangerous. 

His detractors, meanwhile, smell something fishy. Is the new Fed chair not making pre-commitments because he doesn’t have a full grasp of his brief or, even worse, does the US President have an undue influence over the independent central bank? 

Either way, the problem for Warsh is that he’s now set a stubborn communications precedent. Should the markets ‘price in’ a major monetary change which isn’t really going to happen or another economic or political shock hits the US financial system, how can Warsh respond? Keeping schtum won’t be an option.