New Federal Reserve Chairman Kevin Warsh could begin scaling back the central bank's forward guidance as early as this month, according to observers. Having advocated reforming the Fed's communication system even before taking office, Warsh is expected to view the existing framework as sending excessive signals to markets and constraining policy flexibility, and may begin revisions as early as the June Federal Open Market Committee (FOMC) meeting. However, some warn that financial market volatility could widen if the Fed changes its communication style while market rate forecasts are being significantly shaken by the fallout from the Iran war.
According to the Financial Times (FT) on the 3rd (local time), former senior Fed officials expect Warsh to begin scaling back forward guidance as early as this month's FOMC meeting. Forward guidance is a communication tool through which a central bank provides markets with advance signals about the future path of interest rates or policy direction. In particular, during the period when the benchmark rate fell to near-zero levels after the global financial crisis, it was used as a key policy tool to lower long-term rates and manage market expectations.
In the market, there is a view that Warsh could first target the dot plot. The dot plot is a system introduced by former Fed Chairman Ben Bernanke in 2012 that visually shows the projections FOMC members hold for future interest rate levels. The 19 members submit forecasts each quarter for appropriate rate levels one, two, and three years out, as well as for the long-term rate. However, former Fed officials anticipated that Warsh could refuse to submit the dot plot starting from this FOMC meeting.
Warsh is also expected to consider scaling back language in the FOMC statement that hints at the policy stance. Until now, markets have interpreted from the statement's wording whether the Fed is favorable to rate cuts or is keeping in mind the possibility of further tightening. However, Warsh is known to hold the position that such signaling should also be reduced.
Warsh has emphasized reforming the Fed, advocating a reduction in forward guidance even before taking office. In fact, at his Senate confirmation hearing last May, he said, "I do not believe in forward guidance," adding, "I do not think we should be pre-announcing future policy decisions."
This is because Warsh views the Fed's guidance as causing considerable side effects for policy decisions and markets. The view is that it makes policymakers cling to existing forecasts even when economic conditions have changed, potentially triggering policy errors. The dot plot, too, was introduced as a reference for policy direction, but in the market it is effectively received as a signal foreshadowing the future path of interest rates.
However, opinions are divided inside and outside the Fed over whether such tools can be abolished all at once. In particular, some point out that policy uncertainty could grow if the Fed's communication system also changes while market rate forecasts are unstable due to the fallout from the Iran war. James Bullard, former president of the Federal Reserve Bank of St. Louis, said regarding the abolition of the dot plot that it "undermines the international standard that central banks should broadly disclose their policy decision-making process to markets."
