After Kevin Warsh took over the Federal Reserve this spring, he said he wanted investors to watch the economy, not the Fed: Play the ball, not the referee.
Last week, the referees stepped in.
In quick succession, the other two members of the chairman's traditional inner circle, New York Fed President John Williams and Vice Chair Philip Jefferson, signaled that the central bank was in no hurry to raise interest rates again this month. Investors' odds on an October increase, which had steadily climbed to around 70% after Warsh explained his thinking behind last month's rate rise, tumbled to around 25% before last Friday's jobs report, which pushed them lower still.
Fed officials have long fretted that signaling their next move can trap them into a course they might later decide isn't warranted. That concern is central to Warsh's approach to communicating.
But last week revealed a risk on the other side. When officials lay out their views on the economy while saying little about their tactics, investors connect the dots themselves.
"You don't have to promise a path of rates for people to find an implied path of rates," said Eric Rosengren, who was president of the Boston Fed from 2007 to 2021. "There's a cost to saying, 'I'm an inflation hawk.' And that cost is [investors] are going to anticipate that rates are going to have to go a good bit higher."
By late September, many had concluded that Warsh's explanation of last month's rate increase, including that rates weren't yet restraining the economy and that inflation needed to fall "at sufficient speed," provided ample justification to raise rates again when officials meet on Oct. 27-28.
That left officials in a bind. Holding off on an expected rate increase later this month would jolt investors and invite an awkward question: If rates aren't restraining the economy and inflation needs to come down more quickly, why wait? But raising rates before they thought it necessary, days before the midterm elections, carries costs of its own.
In September, officials' projections left room to wait because most penciled in one more increase this year, which could come at either the October or December meeting. A few carefully placed words from Williams and Jefferson offered a way out, resetting expectations without requiring Warsh to depart from his own approach. As New York Fed president, Williams also serves as vice chair of the Fed's rate-setting committee.
Williams and Jefferson don't always signal where rates are headed. But when they have, they have rarely said anything that would box the chair into a course he didn't support, and there is no sign that standard has changed under Warsh.
If officials didn't intend to raise rates as quickly as markets expected, "then you need to bring down expectations," Rosengren said. "It would be awkward for him to do it himself. So he's doing it through his two vice chairs."
The signals were unusually pointed. Williams said another increase "late this year" might be appropriate but that there was "no need for urgency," a week after he told an audience in London that the era of forward guidance was over.
"That's way more specific than he needed to be," said Kurt Lewis, a former senior Fed adviser who is now head of central bank policy at investment bank Piper Sandler.
The remarks also came far in advance of the next meeting, before new economic developments could materialize. "If what you're trying to tell people is, 'We think the market has got a little bit ahead of itself,' it's easier to tell them that before the data," Lewis said.
Forecasters got the hint. Lewis dropped his call for an October increase after Williams and Jefferson spoke. Economists at Goldman Sachs and RBC Capital Markets also abandoned forecasts of an October hike last week. They joined the vast majority of analysts, who expect another hike in December.
While little in the way of new data had arrived to change the outlook, one thing had: Bond yields kept rising. The 10-year Treasury note yield climbed to around 5.25% by early last week from 5% after the Fed's Sept. 16 rate increase, part of a broader, global rise in long-term rates. Jefferson noted the rise in his remarks.
Higher long-term rates can slow the economy and accomplish the Fed's work of slowing investment and borrowing. But with government and corporate debt far higher than in past tightening cycles, it could also be harder to assess what a sustained jump in long-term rates does to the economy if it unfolds rapidly.
The calendar complicates matters further. Warsh has said he wants officials to make decisions at their meetings rather than preview them ahead of time, but at this next meeting, any surprise carries a political risk because it is six days ahead of the midterm elections.
"A one-meeting delay in rates won't make a big difference economically, but could make a big difference politically," Rosengren said. If markets expected an increase that the Fed didn't deliver, "somebody in the administration can say, 'You've affected the election by conveying a path that you're actually not going to follow.'"
The episode doesn't mean Warsh has given up on weaning markets off the Fed's signals. "Every chair experiences a period in which markets interpret the words very differently than they anticipated and have to correct," Rosengren said. "Most normal people are not used to having hundreds of millions of dollars bet on the nuances of your speeches."
Warsh appears to be adjusting the same way, by refining his approach rather than abandoning it.
Loretta Mester, who as Cleveland Fed president from 2014 to 2024 called for the institution to explain how it reacts to economic developments, said the episode showed the limits of leaving markets to guess. "Nature abhors a vacuum, and really, the only person who can speak for the committee is the chair," she said.
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