New Fed Chair Kevin Warsh is deliberately scaling back the explicit policy guidance the Federal Reserve has given markets since the dot-com bust, unsettling Wall Street investors who rely on it to gauge future policy. The Fed also left interest rates unchanged even though inflation is running hot, leading some on Wall Street to question whether Warsh is avoiding a hike to appease the President. The bond market has responded by pushing long-term yields higher.
Kevin Warsh, the new Federal Reserve chair, is deliberately unsettling Wall Street by pulling back on the explicit policy guidance the central bank has given markets for decades. The change ends a communication style Fed chairs have followed since the turn of the century, leaving investors crying foul and questioning the Fed's credibility.
A guidance regime built after the dot-com bust
The bursting of the dot-com bubble caused a massive market shock at the turn of the century. In response, then-Fed Chair Alan Greenspan began issuing forward-looking statements to soothe markets, and his successor, Ben Bernanke, expanded that guidance further during the Great Recession. That level of explicit guidance held until this year, when Warsh started pulling back on it.
Wall Street doesn't like change, so some of the pushback is simply a reaction to the new approach. But Warsh has a reason for it: the market has come to rely on the so-called Fed put, the belief that the Fed will step in to save it, which encourages risk-taking that likely wouldn't happen otherwise. Warsh appears to believe that less guidance will push investors toward better long-term decisions.
Rates hold steady despite hot inflation
Before becoming Fed chair, Warsh was outspoken about wanting lower interest rates, a position the President has also called for publicly many times. Yet inflation is running hot right now, which would normally push rates higher, and the Fed left rates unchanged at its last meeting. That combination has some on Wall Street questioning whether Warsh is trying to avoid a rate increase to appease the President.
Meanwhile, the bond market has reacted to the shift by pushing long-term rates higher. Some market watchers argue this simply forces Wall Street to do work it had outsourced to the Fed under recent regimes, and that this is a good outcome.
The one certainty is less certainty
Changes in interest rates carry real-world consequences, so this isn't idle drama. But regardless of one's view of the shift, the material outcome is increased uncertainty about where policy goes next. That seems to be what Warsh is aiming for.
Source: The Motley Fool
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