A Federal Reserve Stuck in Limbo

Federal Reserve Chairman Kevin Warsh’s second press conference this week left many confused, including reporters and economists like me who closely follow the Fed. Markets temporarily reacted negatively, too. Of what they could decipher, they didn’t like.

The unease lingering now around the Warsh Fed can be owed to something that the chairman hasn’t had enough time yet to address: The Fed still has no objective framework for setting its federal-funds rate target.

Some bumps in the road are unavoidable as Warsh attempts to reform an institution that is in serious need of fixing, and a departure from business as usual at the press conference was to be expected given Warsh’s strong opposition to providing forward guidance. He is correct to be skeptical of Fedspeak, at least in the way that it has existed since 2008.

Forward guidance became a way of committing the Fed to rate moves the data no longer supported and often provided signals that contradicted financial markets. In any case, the forecasts that once filled these meetings were frequently wrong, the years the Fed spent in the early 2020s insisting inflation would prove “transitory” being a stark example. But in the absence of forward guidance, there appeared on Wednesday to be a dearth of substance.

Warsh’s first news conference in June felt fuller, but only because he had news to deliver on the five new task forces to overhaul how the Fed operates. With that announcement spent and forward guidance gone by design, the only substantive thing the July presser could offer was a concrete framework for how the Federal Open Market Committee is making its rate decisions. That never surfaced, and not for reporters’ lack of trying. It never surfaced because no such framework exists.

The result is that we saw at the podium a Fed stuck in limbo—caught between a past Fed of excessive speechmaking and a positively reformed Fed that has yet to materialize. Without forward guidance, Warsh has no objective reaction function for setting rates, at least none that he is willing to publicly share.

There was a fascinating example of this at the presser. Warsh accurately observed that virtually all market rates had climbed significantly even though the Fed had not changed its target rate all year. While his reading of the data was correct, he inaccurately credited the omission of forward guidance as the reason markets were diverging from the Fed policy rate.

In fact, market rates decoupled from the fed-funds rate back in 2008, when the interbank lending market seized up and the Fed moved to a floor system awash in reserves. The same-month correlation between 30-year mortgage rates and the fed-funds rate, for example, has weakened drastically.

The Fed isn’t using this information to its advantage. Despite Warsh rightly believing that markets set prices far better than the Fed, he declined to vote for a interest-rate hike to bring the Fed’s policy stance more in line with markets. These are the cracks that appear when Fed members fail to provide a clear framework for their policy decisions.

It isn’t just Warsh who lacks a clear, objective interest rate framework. The hawks on the rate-setting committee don’t supply one either. The three dissenters who voted to raise rates this week could charitably be viewed as a disciplined alternative—a thoughtful bloc taking inflation seriously. But their record says otherwise.

In March, not a single Fed policymaker, including the three dissenters, projected a rate increase for the year. In fact, the median projection made this spring by policymakers was a rate cut, even as inflation ran well above the Fed’s 2% target. By June, the projections had swung toward a hike, and now three officials want to hike at once. All of this, despite no significant change to core inflation, which is just as elevated now as it has been all year. (Material inflationary pressures like tariffs, the Iran war, and the federal government’s unsustainable spending have remained broadly the same for months, too.)

The truth is that the FOMC isn’t relying on an objective rate framework, which explains the confusion.

Fortunately, the FOMC can fix this problem by adopting a clear rules-based monetary policy approach that will help indicate to the public where rates will move, and the committee doesn’t have to wait for the task forces to finish their work to do it. Everything Warsh says he wants—a Fed that talks less, that tracks economic conditions the way markets already do, that isn’t the center of every financial conversation—describes an explicit policy rule. Adopting one for the FOMC as a whole, or asking each member to provide their own, can turn these news conferences into useful sources of information and debate rather than a monthslong waiting game for task forces.

Warsh’s restraint on guidance isn’t itself the issue. But it has exposed deeper structural cracks at the central bank. In the absence of a clear framework, continue to expect more bumps in the road.