Key Takeaways
- New Fed Chair Kevin Warsh is already reshaping policy communication by reducing forward guidance, questioning the dot plot’s future and emphasizing real-time data, potentially increasing Treasury market volatility.
- Warsh’s push to shrink the Fed’s balance sheet and eventually eliminate MBS holdings signals a return to a more traditional, Treasury-focused policy framework.
- While markets have begun pricing in rate hikes, Warsh’s commitment to the 2% inflation target supports a higher-for-longer rate outlook and a cautious stance on easing expectations.
The June FOMC meeting will go down in history as a milestone event in U.S. monetary policy. Interestingly, it was not the decision to keep interest rates on hold or remove the easing bias per se, but rather Kevin Warsh taking charge as the new Fed Chair and placing his stamp on the future direction of policymaking and its communication to the public. In fact, five task forces have been formed to do just that.
The changes Warsh referred to at his presser should not have come as a surprise to investors. Forward guidance and the Fed’s balance sheet had been clearly identified as two key areas the Chair would focus on. Let’s take a look at where a Warsh-led Fed may be taking the money and bond markets.
Forward Guidance
- The easiest change to implement with respect to forward guidance was the policy statement that gets released after the FOMC meeting. The ‘new’ version which appeared was actually a throwback to the days of Chairman Greenspan, where the statement simply presented the facts: the meeting’s rate outcome—what the result was, the number of votes in favor (not who) and a marking to market on the economy and inflation.
- While the dot-plot may still linger for the remainder of this year, it appears as if its days are numbered and could be gone in 2027. Underscoring this point was Warsh’s own admission that he did not partake in the June go-round.
- Warsh did acknowledge that press conferences can be a “very useful way to communicate”, but what they will look like or entail in the future remains open to debate.
Read more: There's a New Sheriff in Town! Will He Act Differently Than the Old Sheriff?
Balance Sheet
- It was well-known that Warsh is not a fan of the large Fed balance sheet and that stance has not changed. Not only does the new Chair want to reduce the Fed’s bond holdings, but the shared goal of essentially all members is to reach a point where the System Open Market Account holds only Treasuries, and no mortgage-backed securities (MBS).
What About the Data Inputs?
- Interestingly, Warsh stated that some of the economic data that is used for policymaking decisions might be an “echo of history”, suggesting that decisions could be made using flawed inputs. The Chairman emphasized he was “open minded” about new data sources, particularly ‘real-time’ information.
Treasury Market Reaction Function
- While there seems to be some debate as to what effect this ‘new’ forward guidance approach will have on the UST market, in my opinion, it won’t reduce volatility, but could potentially increase it, as the broader money and bond markets react to each incoming data point that may influence policy decisions.
Bottom Line
While the Fed’s ‘Warsh out’ provides an interesting topic for discussion, the bottom line still comes down to: where are rates headed? The new Chairman’s emphasis on the Fed’s 2% inflation target was a clear sign that he will not be a rubber-stamp for rate cuts, and he also mentioned that, outside of housing, it’s “hard to say policy is restrictive.” This has pushed fed funds futures to price in a rate hike at the September FOMC meeting and two total by March 2027.
Unless upcoming employment and inflation data argue for a potential rate hike, our base case scenario still sees the Fed on hold for the remainder of this year.
Kevin serves as the Head of Investment and Fixed Income Strategy.
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