What will the less talkative Federal Reserve bring to the market?

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The Fed Should "Talk Less"

Regarding the proposals of the new Fed Chairman Kevin Warsh, most media and investors may focus on "interest rate cuts" and "balance sheet reduction." Today, let's talk about one of his viewpoints that many people usually don't pay much attention to: In the future, the Fed may deliberately "talk less." (For an interpretation of his proposal of interest rate cuts + balance sheet reduction, you can read the article "A Storm Is Coming: 'Interest Rate Cuts + Balance Sheet Reduction' Is More Poisonous Than Interest Rate Hikes")

This is a view clearly expressed by Kevin Warsh at the hearing. He not only opposes "forward guidance" but also implies:

In the future, the Fed should talk less, hold fewer press conferences, reduce the use of dot plots, and stop "drawing roadmaps" for the market.

In the past few years, there was a view in the domestic financial circle that the People's Bank of China should learn from the Fed, communicate with the market frequently, increase transparency, and manage market expectations well. In fact, in recent years, the People's Bank of China has increased the frequency of communication with the market and has frequently mentioned "strengthening expectation guidance" in its reports.

After learning for so long, the "master" has started to change direction. No wonder many people's first reaction after hearing this is a bunch of questions: "Isn't this a regression?" "Shouldn't the central bank be as transparent as possible?" "Isn't the market most afraid of uncertainty?"

But the problem lies precisely here. The People's Bank of China used to have insufficient expectation guidance, but the Fed may have gone too far on the road of expectation management, to the extent that it is overwhelmed and wants to "step down from the altar."

Is it better for the central bank to be more transparent?

In the past 15 years, the Fed has become more and more transparent and loves to communicate. As a result, the market has become more and more fragile. There has even been a very strange phenomenon: The market no longer analyzes the economy but analyzes the tone of a single sentence from the Fed.

Therefore, to understand Warsh's proposal, one must first understand how the Fed has changed from a "mysterious force" to a "talkative central bank."

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The Central Bank Has Become a Market Expectation Management Institution

Global investors may have gotten used to the current environment. After each FOMC meeting, there must be a press conference, economic forecasts, and regular dot plots. Usually, officials take turns to speak. The market interprets "hawkish" and "dovish" from these fragmented pieces of information every day.

But in fact, this is a very new thing in the history of the Fed. Even before the 1990s, the Fed didn't even actively announce "whether to raise interest rates."

The most classic quote comes from Alan Greenspan: "If you understood what I said, I must have misspoken."

When I quoted this sentence last time, someone said, "I remember the second half of the sentence was 'then you must have misunderstood.'" In fact, Greenspan deliberately worded it in a way that allows for both translations, which just reflects the Fed's management philosophy at that time: The central bank must retain ambiguity.

Warsh highly praised Greenspan at his inauguration ceremony but didn't mention his former boss Ben Bernanke at all, which also represents his policy inclination.

Why? Warsh believes that monetary policy faces a constantly changing economic system. The Fed should be like a "battlefield commander" and flexibly adjust policies according to real - time situations. This requires constantly overturning its own judgments and it's impossible to clearly state the future policy path in advance.

What really changed this management philosophy was the 2008 financial crisis. At that time, interest rates had dropped to near zero, but the financial market was still frozen, and traditional monetary policies had failed.

So, in addition to QE, the Fed invented a new tool - forward guidance. It not only tells the market what the interest rate is today but also tells you what it might be in the next few years, such as "maintaining low interest rates for a long time," "not raising interest rates until the unemployment rate drops to a certain level," and "maintaining a loose policy for some time." In essence, it aims to influence market expectations.

So, during Bernanke's era, the Fed formed a set of systematic practices and began to be more and more like an "expectation management institution." This was further strengthened during Yellen's era and reached its peak during Powell's era.

But at the same time, the global financial market has also gradually developed a dependence. It no longer pays attention to the economy itself but to what the Fed is thinking. Asset prices are becoming more and more dependent on the central bank's language.

Everyone should remember that every time the FOMC meets, investors don't analyze monetary policy itself but analyze whether "higher for longer" has been removed, whether the word "somewhat" is still there, and how many times Powell used the word "confident" in the press conference. There are even quantitative strategies specifically tracking the frequency changes of words in the Fed's speeches.

This actually strengthens financial fragility.

The market first tasted the "bitter fruit" in 2013. When Bernanke just hinted that QE might be scaled back in the future, just a hint, the global market crashed directly, the yield of US Treasury bonds soared, capital flowed out of emerging markets, and the exchange rates of many countries collapsed. So "Taper Tantrum" is a term later used by the market to describe a phenomenon: As long as the Fed sends out a signal of contraction, without actually doing it, it will trigger a round of market decline.

Another trap is the psychological phenomenon of "commitment - consistency."

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The "Mr. Too Late" Who Is Trapped by His Own Actions

The "principle of commitment and consistency" is a psychological phenomenon. It means that after an individual makes a commitment actively, publicly, and voluntarily, due to the inner need for consistency between words and deeds, they are more likely to take actions consistent with the commitment to reduce cognitive dissonance and maintain their self - image.

The most typical tool is the dot plot.

Each dot on the dot plot represents a Fed official's prediction of the future interest rate path. The purpose of this tool is to improve policy transparency. But in reality, the market regards it as the Fed's commitment to the future rather than an individual prediction, and then uses it to verify the Fed's interest rate path, making the Fed feel "trapped by its own actions."

The most classic "fiasco" of the Fed was the "transitory inflation theory" in 2021.

At that time, when the CPI was rising, the Fed continuously emphasized that inflation was only "temporary," believing that inflation would naturally fall back after the supply chain recovered, so it was reluctant to raise interest rates for a long time.

As a result, inflation soared all the way, and the US CPI once exceeded 9%. The Fed had to resort to historically violent interest rate hikes to remedy the situation. Powell was even given a nickname by Trump - "Mr. Too Late."

Although the Fed's statements, dot plots, etc., are just predictions of the market, not commitments, once the words are out, they can't be taken back. The market has regarded them as commitments, and the Fed is reluctant to change direction immediately due to concerns about its credibility.

After the market has formed a high - level dependence on the central bank's communication, the central bank falls into a paradox: The more you communicate, the more the market depends on communication; the more the market depends on communication, the less you can change your wording casually.

Finally, the central bank loses its freedom.

This is what Warsh said: Forward guidance will reduce policy flexibility, and you can't write a "script" for the market in advance.

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It's Easy to Be Proven Wrong When Predicting the Market

Back to the question at the beginning, is it better for the central bank to be more transparent?

More and more people are beginning to realize that too much information released by the central bank may not be a good thing. The modern financial market will over - trade on central bank information. In fact, many times, it's not that the economic fundamentals have changed, but just the wording of a Fed official has changed.

In the past, there were only a few meetings a year. Now, there are almost daily speeches by Fed officials. As a result, the market is repricing every day. Asset fluctuations are becoming more short - term, and it's more difficult for long - term funds to make decisions.

This is actually a kind of "noisy monetary policy." Warsh emphasizes "policy independence" not in the sense of being independent of the government, but the central bank should not provide the market with an "illusion of certainty." If the central bank guides the market and predicts the future every day, it will be proven wrong again and again, and its credibility will decline.

So he proposes: talk less; hold fewer press conferences; provide fewer short - term paths; reduce the use of dot plots; and have more internal debates.

His choice of inflation indicators also reflects this concept.

The traditional indicator used by the Fed is core PCE. It excludes food and energy because these two items fluctuate greatly and are likely to interfere with judgment.

But Warsh doesn't quite agree with this logic. Why only exclude eggs and gasoline? This is actually empiricism. He prefers two indicators: the trimmed mean and the median. The former means removing one highest value and one lowest value and then taking the average. Both of these indicators use statistical methods to filter out noise, which reflects Warsh's concept of not artificially interfering with signals.

Warsh believes that a truly robust system must allow for differences. Too much consistency can easily lead to groupthink, and groupthink is related to many large - scale financial crises.

Of course, Warsh's idea is very controversial.

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Three Changes Faced by Investors

Many economists believe that the modern financial market is too large. Institutions such as pension funds, ETFs, quantitative funds, and highly leveraged institutions are highly dependent on interest rate path expectations. If the central bank suddenly reduces communication, the market may make frequent misjudgments, and volatility will increase significantly.

Some people also worry that this decrease in transparency will weaken democratic supervision and make the Fed return to the "policy black - box era" before the 1980s. This worry is not unfounded. The Fed has great power. If it becomes mysterious again, the market will suspect whether there are interest - related collusions behind these policies.

If the future is really an era of a central bank where "less is more," investors will face three changes:

First, market volatility may rise in the long term because the certainty of policies has decreased.

Second, the difficulty of short - term trading will increase. In the past, many trades were actually bets on the Fed's wording. In the future, this anchor may become weaker.

Third, the ability to truly study fundamentals will become important again. If the central bank doesn't "spoil the plot" for you, you have to study the economy on your own.

This may make the market return to the situation where "asset pricing is based on long - term logic" rather than "a single sentence from the central bank."

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Learn to Face Uncertainty Again

In fact, Warsh doesn't give up the Fed's responsibility of regulating the market. He is more inclined to the traditional elite decision - making logic.

In the past few years, the market liked to trade on the subtle changes in monthly non - farm payrolls, CPI, and PCE. When important data were released, the whole market became a "data guessing game." But Warsh pays more attention to whether AI can improve productivity, the long - term supply capacity of the United States, and industrial capital expenditures, which are long - term and grand changes.

His classic statement is: The numbers after the decimal point of the interest rate are not important. The numbers before the decimal point are important.

So in the future, Warsh may weaken the dependence on short - term data and strengthen the long - term narrative. Monetary policy may return to "structural judgment" instead of focusing on monthly data fluctuations every day.

What Warsh really challenges is the entire set of "communicative monetary policies" formed by global central banks. A "less - talkative" Fed will make the market learn to face uncertainty again.

This article is from the WeChat official account "lig0624" (ID: tongyipaocha), written by SIXIANG GANGYIN, and is published by 36Kr with authorization.