Kevin Warsh faces tenuous balancing act in first Fed meeting as chairman

Kevin Warsh faces a delicate debut as Fed chief, balancing inflation risks, market expectations and Trump's calls for lower rates

By Colby Smith

 

Kevin M Warsh is no stranger to delicate balancing acts, having helped formulate the Federal Reserve’s response to the global financial crisis as a governor more than a decade ago. But the tightrope that he must now navigate as chairman of the central bank is particularly precarious. 

Warsh, just weeks into his tenure at the helm of the Fed, has inherited a multitude of economic challenges. A deal has been struck to end the war with Iran, but the energy shock caused by months of tension has lifted inflation to the highest level in three years. Officials at the central bank appear at odds over the need to more openly consider raising interest rates. And uncertainty over what message Warsh, who has called for regime change at the Fed, will send at his first news conference on Wednesday has kept financial markets on edge. 

 

A decision by Warsh to downplay price pressures and talk up rate cuts would generate significant pushback from several of his new colleagues. It would also raise questions about his commitment to eventually returning inflation to the Fed’s 2 per cent target. Talking tough on inflation and keeping open the option of rate increases would help to burnish his credibility but risk angering American President Trump, who has not wavered in his desire for lower interest rates. 

Warsh’s pledge to recast how the Fed communicates adds yet another complication. He thinks policymakers should speak less frequently and resist providing signals about what the central bank might do next with rates. This so-called forward guidance boxes the Fed in, he has argued, making it harder for them to pivot if necessary. 

Warsh will do his best on Wednesday to avoid providing a steer in either direction — an approach that risks injecting an added dose of volatility into markets already bracing for a rate increase around year-end. 

“Just given the novelty of the moment, because it’s Warsh’s first press conference, there’s really a lot of scope for what you might call a ‘market misinterpretation’ of his message,” said Kris Dawsey, head of economic research at the DE Shaw Group, a hedge fund. “It’s going to take some time for the market to really get calibrated on his communications.” 

The Fed on Wednesday is set to hold rates steady at a range of 3.5 per cent to 3.75 per cent for a fourth straight meeting. The policy statement that will accompany the rate decision is likely to scrap what officials have described as an “easing bias,” a stance that suggests a rate reduction is the most plausible next move. It generated opposition at the last meeting. 

What will be hard to immediately discern is if the changes to the statement reflect growing support within the Fed to consider rate increases or if it is simply a byproduct of Warsh’s longstanding objection to forward guidance.  

The statement on Wednesday will be accompanied by the “dot plot,” which aggregates what all 19 policymakers surmise will happen to rates over the coming years. The central bank also publishes what it expects to happen to inflation, unemployment and growth over that same time horizon. 

One of Warsh’s first decisions as chairman revolves around whether he will provide his own projections. Opting out of the process would align with his past criticism of the dot plot and his vow to lead a “reform-oriented” Fed. It would also help to shift the focus away from what Ellen Meade, who was a senior adviser to the Fed’s board of governors until 2021 and is now a professor at Duke University, described as the “ridiculousness of microscoping the dots.” 

But there could be drawbacks. “To not do so would look like a spiteful dissent against his own committee,” said Michael Feroli, chief US economist at JP Morgan. 

It is this group of policymakers that Warsh will need to persuade if he is to make progress on the changes he wants to enact, including shrinking the Fed’s $6.7 trillion portfolio of government bonds and mortgage-backed securities. 

Modifications to the cadence or the content of what the Fed publishes in terms of officials’ forecasts do not require final approval by the committee, said Kurt Lewis, who served as a senior adviser to Jerome H Powell while he was Fed chair. 

But Lewis stressed that making these changes unilaterally would be a break with tradition. In the past, such alterations have occurred only after extensive deliberation until a consensus was reached, even if the support was not unanimous in the end. That was the case in 2012 when the Fed began publishing officials’ rate projections. 

With or without Warsh’s forecast, most officials are poised to scale back their expectations for rate cuts from estimates three months ago. As a result, the median estimate is expected to at a minimum show no cuts by year-end rather than the quarter-point reduction that was previously forecast. A number of officials are likely to pencil in a rate increase, reflecting what is expected to be a significant revision higher in the inflation forecast.

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