Stock and bond investors panned the Fed chair's lack of communication
Kevin Warsh already has a lot of doubters after just a few months as new Federal Reserve chair.
Kevin Warsh insists the Federal Reserve will do whatever it takes to reduce U.S. inflation to its 2% target.
But, for now, investors aren't buying it.
The new Fed chair shook Wall Street on Wednesday with his reluctance to reveal his thinking on the economy and his skepticism about the tools the Fed uses to judge inflation. He even raised doubts among investors about his willingness to increase interest rates to get prices under control.
"I left less confident that Chair Warsh would deem that appropriate," said Mike Lorizio, head of U.S. rates and mortgage trading at Manulife Investment Management.
The central bank on Wednesday kept its benchmark short-term interest rate unchanged, but not without some drama. Three of the 12 senior Fed officials who vote on interest rates favored an increase, marking the most dissents since 2016.
Investors and economists acknowledge the Fed vote was a close call, and that a case could have been made either way to raise rates or leave them unchanged.
Yet Warsh's unwillingness to open up about his views disappointed investors, and sparked questions about whether he would take the necessary action to back up his tough talk on inflation.
After Warsh's second press conference as Fed chief Wednesday, stocks tanked and bonds also reacted badly.
"The reviews generally are not good," said Robert Tipp, PGIM's head of global bonds and chief investment strategist.
It's far too early to suggest Warsh and the Fed have lost credibility, but the reaction of Wall Street DJIA SPX COMP is an ominous sign.
Some of the disappointment, to be sure, is simply markets trying to get used to the very different style of Warsh compared to predecessors Ben Bernanke, Janet Yellen and Jerome Powell.
He does not believe in so-called forward guidance - hints to markets as to what the Fed will do with interest rates and why. The result is a sudden information vacuum at the Fed after more than 15 years of a very open communication style.
"I have no problem cutting back on forward guidance, but I think he took it a little too far," said Richard Moody, chief economist at Regions Financial. "Don't stand there for an hour [at a press conference] if you are not going to say anything."
Moody said it usually takes markets a while to adjust to any new Fed chair. The break-in process could take even longer given Warsh's big divergence with past chiefs.
Lorizio admitted as much. "The communication style is going to take some time to get used to," he said.
Warsh further muddied the waters by casting doubt on the quality of the measures used to judge inflation - namely, the Fed's longtime favorite, the personal-consumption expenditures (PCE) index. Investors are wondering how the Fed can do anything if it doesn't trust its own tools.
"I am looking at a broader set of inflation data than PCE," Warsh said. "My lens is a lot broader than that."
Warsh even suggested that the Fed raising interest rates is just one tool to depress inflation, raising questions about what else he has in mind.
"If inflation continues to be elevated through the forecast period, interest rates could well be part of that solution," Warsh said. "But I wouldn't say it's in isolation."
What else could Warsh do? The Fed could sharply reduce its holdings of trillions of dollars in Treasurys, for one thing. Such a move could hurt bondholders.
Warsh has talked about big balance-sheet reductions in the past, but such a proposal would lack the support of the full Fed board and is highly unlikely.
Whatever Warsh's leanings, economists also point out that he is just one voter on a 12-member committee that sets the key U.S. interest rate. If the rest of the committee thinks it needs to raise rates to restrain inflation, that's precisely what it will do, whether Warsh approves or not.
"Whatever skepticism traders may have of Warsh, the rest of the committee has not wavered," said Will Compernolle, macro strategist at FHN Financial. "There were three voters that favored a rate hike yesterday and, at the end of the day, Warsh is only one of 12 voters."
In the meantime, Wall Street has already done some of the work to restrain inflation. Longer-term rates have risen since Warsh took over at the Fed, making it more expensive for people and companies to borrow.
"[Fed officials] want tighter financial conditions and they have been getting it," Tipp of PGIM said.
"Yields are higher, spreads are wider and stocks are lower," he added. "Those are some of the things that lets some of the air out of the balloon by discouraging borrowing and crimping consumption and investment."
-Jeffry Bartash -Joy Wiltermuth
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