One imagines that Federal Reserve Chairman Kevin Warsh is feeling quite worried about inflation right about now.
Despite the Federal Open Market Committee raising the federal-funds rate last month, money still feels easy to come by. Stocks are trading near record highs, and prices are accelerating across the economy. Inflation data released by the Bureau of Labor Statistics this week show that, in September, producer prices had their largest monthly gain in more than four years, and consumer prices rose 3.7% from a year earlier. Core consumer prices, excluding volatile food and energy categories, climbed 2.6%, up from 2.4% in August.
And Warsh still won't say what the Fed will do next or how it will respond to the incoming data. Much to the chagrin of Fed watchers and markets, his silence is intentional. He prefers to hear what markets have to say -- "unfiltered."
Warsh has long been skeptical of offering forward guidance, or guidance of pretty much any kind. For example, he has chosen not to reveal his Fed's "reaction function": an explanation of how the voting committee weighs its goals of stable prices and maximum employment, how far the economy is from them, and how fast it expects to get there.
Unfortunately, that reluctance to spell out a reaction function is creating unnecessary market volatility, as evidenced by the gyration in rates after Wednesday's morning's consumer price index report. With wars raging, technological innovation accelerating at an unprecedented pace, and supply shocks rolling across continents, markets need stability more than ever. Each disruption pushes inflation further away from its inflation target and eats away at the Fed's credibility.
In the vacuum created by Warsh's silence, investors have to parse through other Fed officials' speeches and interviews to make sense of what might be coming. But even those remarks give conflicting directions.
In a recent speech, New York Fed President John Williams said that "there is no need for urgency" in raising rates further. We have time to wait and see what happens with inflation, he said. Dallas Fed President Lorie Logan, however, said a few days later that the target rate needs to go up another 50 basis points. (A basis point is a hundredth of a percentage point.) And Cleveland Fed President Beth Hammack told Barron's last week that policy should be more restrictive. "I personally prefer doing smaller moves more frequently," she said.
So, although Warsh has repeatedly pledged to restore price stability, it still isn't clear how he and his board plan to do so. Investors need to understand how the Fed processes information when deciding what it will do next. If data come in hot or cold, what will the Fed do with rates?
One way Warsh could give some guidance without boxing in the Fed is by laying out specific scenarios for the economy and exactly how policy would respond. This approach could replace the modal forecast and incentivize investors to think through different outcomes and associated probabilities.
Scenario planning isn't without its challenges. Someone has to decide which scenarios are even worth considering, what odds to assign to those scenarios, and who will make those calls -- whether Fed staff or policymakers. These are hard decisions, but that isn't an excuse for avoiding them.
The next FOMC meeting is on Oct. 27. Investors see about a 30% chance that the committee will raise rates then. Markets are pricing in roughly two more hikes by January and another by April. Will the Fed try to steer market expectations, or let markets reprice on their own, even if that means more volatility?
Some clarity may come after Warsh's new task force on communications delivers its findings and recommendations, which Warsh has said will be at the end of the year. Drilling down on the musings of one of that task force's leaders, former Bank of England governor Mervyn King, offers insights on what may be coming. In King's 2021 book, Radical Uncertainty, he argued that when the range of monetary policy outcomes is wide and uncertainty can't be quantified, forward guidance is only an illusion.
"The communications of a central bank need to focus on explaining its reaction function and developing a narrative about the state of the economy that changes over time meeting by meeting, report by report," King wrote.
I'm hopeful that King's appointment will shape Warsh's thinking on how the Fed communicates policy deliberations and decisions amid uncertainty.
At a time when the Fed's independence and credibility on inflation is being stress-tested, clarity is more than just about making investors happy. Clarity around the Fed's thinking lets Congress and the public hold it accountable for meeting its dual mandate of maximum employment and 2% inflation. In other words, transparency helps build credibility. The Fed owes the public that for its independence.
Guest commentaries like this one are written by authors outside the Barron's newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.
Fabio Natalucci is the CEO of the Andersen Institute for Finance and Economics. He has held senior roles in the Division of Monetary Affairs at the Federal Reserve Board, the U.S. Treasury Department, and the Monetary and Capital Market Department at the International Monetary Fund.
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