FOMC Watch – Warsh’s Jackson Hole Debut

Kevin Warsh is about to give his first speech at Jackson Hole. New Fed Chairs have typically used that first speech to outline their economic worldview, effectively revealing their reaction function. For Kevin Warsh this is even more important than his predecessors due to markets and economists being unable to distil something even akin to a reaction function from his commentary. One could attribute that to the fact that he has had less time in office than his predecessors, who had February, rather than May confirmations. But the real reason is his deliberate lack of communication. In the post-meeting press conferences, he’s evaded questions on his views on the inflation trajectory and failed to explain why the FOMC held rates steady in July, despite three dissenters. A lack of clarity would be manageable in quiet times, but becomes increasingly difficult to deal with when it starts contributing, in addition to other factors, to rising term premia. It becomes even harder to deal with when the Treasury is seemingly on a collision course with what little we do know of Warsh’s ideas about how the Fed should function.

A History of Firsts

Ben Bernanke’s 2006 speech was called ‘Global Economic Integration: What’s new and what’s not’. It was a relatively academic speech, and it highlighted his views on global interconnectedness which would prove vital two years later. In 2014, Yellen signalled her knowledge and slight tilt towards the labour market in ‘labour market dynamics and monetary policy.’ Powell set out his risk management approach to monetary policy in ‘Monetary policy in a changing economy,’ already anticipating the gradual approach, which we would see in the Fed’s initial pandemic response.

The Jackson Hole speech is therefore an opportunity for a Fed Chair to put an immediate stamp on their tenure. Will Kevin Warsh do the same? Warsh has been vocal about the things he does not like at the Fed and about the way monetary policy has been conducted. We expect this speech to largely follow that same pattern. A constructive outcome would be for Warsh to focus on one or two themes and set out a concrete proposal for institutional change, together with a coherent monetary-policy framework. We see communication, i.e. the lack of forward guidance, and the role of financial markets as the most likely themes. A prepared and scripted speech would be the perfect opportunity, as the ad hoc remarks during the press conference have been less than convincing. We expect his speech to still be light on details, awaiting outcomes of the various taskforces.

The Treasury-Fed Discord

There’s been much talk of a Fed-Treasury accord. We’ve explained our expectations for it here, but it can be broadly summarised as a coordinated effort to reduce the size of the balance sheet. We argued that we saw the possibility of the Fed moving to holding a more market-neutral maturity spectrum of Treasury holdings, as the Fed’s holdings currently have a long-term tilt. We called it a Reverse Operation Twist. Last week, the Treasury Secretary Bessent announced the Treasury would start its own Operation Twist in response to rising long-term yields, that Bessent argues are deviating from fundamentals. To combat those rising yields, the Treasury will increase its buybacks of long-term Treasuries by issuing short-term Treasuries. To increase firepower, they’re considering the use of the Treasury General Account. As this account would have to be filled again at some point, this also adds a timing dimension to the duration adjustment. Ultimately, this would still likely be insufficient to permanently affect yields, only the Fed wields the power to credibly put a cap on yields.

But Warsh’s Fed is unlikely to do that, in the absence of the market becoming disfunctional. Indeed, Warsh has explained his lack of communication as a way to let financial markets do their work again. Markets should ‘play the ball, not the referee’. The one thing we did get from the July FOMC press conference was some information about how Warsh sees the Fed’s role in its interaction with financial markets. He emphasized that he saw substantial tightening in markets, perhaps due to the reduction in forward guidance. He sees this as part of the way monetary policy should operate, and Bessent is putting a spoke in the wheel.

Beyond Warsh, the Treasury’s intervention is likely to be perceived negatively by the rest of the FOMC as well. By attempting to influence the shape of the yield curve, the Treasury risks treading on monetary-policy territory, especially considering the FOMC’s tilt towards tightening. The situation is likely to lead to increased volatility in rates, and markets are looking at Jackson Hole for a response from the Fed. Warsh is stuck between being at least neutral towards the Trump administration, and his vision on the Fed-market interaction, but being silent does not seem like an option.