Kevin Warsh Just Took 30 Years of Fed Culture to the Wood-Chipper
The financial world changed last week.
Yesterday marked the end of the first Federal Open Market Committee (FOMC) meeting under the Fed’s new Chairman Kevin Warsh.
Warsh sent a major, and I mean MAJOR signal to the financial system that he intends to change the Fed in profound ways. If I’m brutally honest, detailing the context and significance of the proposed changes could easily fill an entire book. We don’t have that much space on these pages. So, I’m going to try to provide a lot of context in a short amount of space.
Please bear with me.
Why the Fed Matters
The single most powerful entity in the financial system is the U.S. central bank, called the Federal Reserve, or the Fed for short.
The Fed controls the value of the reserve currency of the world: the U.S. dollar ($USD). It also controls the price of money in the financial system by targeting the yield at which U.S. debt, also called Treasuries trades. This is called the “risk free rate of return” against which all risk assets (stocks, real estate, commodities, etc.) are priced.
The Fed is so powerful it can stop a financial crisis in a matter of days (it literally stopped the COVID-Crash on a dime on March 23, 2020). It has even bailed out other central banks (the EU debt crisis).
Again, the Fed is the single most powerful entity in the financial system.
The Fed is tasked with two items:
- Maximum employment.
- Price stability (inflation).
Historically, the Fed has been something of a discreet entity. If you go back to the 1950s-1980s, rarely was the Federal Reserve in the media. Most Americans couldn’t even name the Fed Chair. And even financial analysts didn’t know the names of the seven members comprising the Fed’s Board of Governors.
How the Fed Went From Quiet Economists to Fame-Obsessed Celebrities
This all changed in the 1990s. At that time, the Fed’s culture, led by then-Fed Chairman Alan Greenspan began to step into the spotlight in unprecedented ways.
For one thing, the Fed intentionally turned a blind eye to the development of a clear stock market bubble: the Tech bubble. Between this and the introduction of online, discount brokers, America experienced its largest stock market bubble in history: a period in which the NASDAQ stock market index (an entire index, not an individual stock) more than tripled in the span of three years.
Alan Greenspan was heralded as a financial visionary who created an environment in which Americans could become wealthy from stock trading in a short period of time. He was called “The Maestro” in the media which hung onto every word he said in public. In fact, the obsession with his person was so over the top that at one point the media talked about the “Briefcase Indicator” which argued that if Greenspan’s briefcase was thin on FOMC days, it indicated no policy change was coming.
All of this was Greenspan’s doing. Up until his tenure, the Fed has largely operated in the shadows with no public statements by Fed officials, no issuance of Fed meeting minutes, and no “forward guidance” e.g. the Fed presenting its forecasts on GDP growth, inflation, and unemployment.
Greenspan changed all of this.
- In 1993, the Fed began revealing the “minutes” from past meetings. For the first time in history, the Fed revealed what was being discussed behind closed doors (albeit at a five-year lag).
- In 1994, the Fed began providing real-time public statements when it made policy changes. Prior to this, the Fed simply acted and the world had to deduce what was going on via activity at the NY Fed’s trading desk (whether the Fed was buying or selling debt to change interest rates). No more. From this point onward the Fed told the world what it was doing in terms of policy changes.
- In 1999, the Fed began making public statements even when it didn’t make any policy changes. Fed officials, particularly Alan Greenspan, were now celebrities.
- In 2003, the Fed began issuing forward guidance via its “dot plots” (a graphic depicting where Fed officials believed GDP growth, inflation, unemployment and other economic data points would be in the future). Apparently Fed officials were so important that the world needed to know what each one of them was thinking about individual economic data points!
In short, in the span of 15 years, the Fed went from a clandestine entity that didn’t even tell the public what it was doing to a fame-crazed circle of economists who looked for every opportunity to share what they were thinking about everything.
This situation has since metastasized to the point that one of the seven members of the Fed Board of Governors or 12 Presidents of the Regional Reserve Bank Presidents is giving a speech or interview nearly every weekday. The media hangs on the words of Fed officials who aren’t even involved in policy decisions!
The Fed also releases a “redline” document of its policy decisions tracking the changes in words/phrases from the prior month’s statement. Bear in mind, the document is typically only 400-600 words in length. But apparently, we need to know if any of those words have changed!
Finally, and perhaps most absurd, the Fed also releases meeting minutes from prior month’s FOMC meetings. As if it’s not enough for them to issue a public statement on what they are doing now (along with a Q&A session with the Fed chair), the Fed believes that we need to know what they were discussing last month.
The result of all these changes is that much of macroanalysis now consists of obsessing over minor details in how the Fed chooses to word things. Trillions of dollars’ worth of capital is allocated based on the thoughts, speeches, and forecasts of 19 people, only 12 of whom are involved in policy changes. Indeed, there have been days in which the entire stock market moved based on a Fed official saying something.
It’s absurd.
Enter new Fed Chair Kevin Warsh.
Kevin Warsh Signals an End to the Worst Era in Fed History
Yesterday was the first FOMC meeting under Warsh’s leadership. And Warsh effectively took the last 30 years of Fed culture to the wood-chipper.
For one thing, Warsh is being referred to as Chairman, as opposed to Chairperson. I’ll leave the political/cultural implications of this up to you.
Secondly, the redline of the Fed’s public statement was a bloodbath with the document reduced from 349 words to 140.
The signal here is that the Fed will no longer be a pontificating entity. Fed public statements will simply be a matter of stating facts, not rambling about what the Fed thinks might or might not happen. The actual Fed statement was just the following:
The Federal Open Market Committee approved the following statement for release by a 12 – 0 vote:
The Committee decided to maintain the target range for the federal funds rate at 3-1/2 to 3-3/4 percent, in support of the Federal Reserve's dual mandate. The Committee reaffirmed its policy of maintaining ample reserves in the banking system.
Economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East. Productivity growth and capital investment are strong. Job gains have kept pace with the workforce, and the unemployment rate has changed little.
Inflation remains elevated relative to the Committee's 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. The Committee will deliver price stability.
The major changes didn’t stop there.
During the subsequent Q&A session, Chairman Warsh delivered the following extraordinary statements:
“I did not submit DOT Plot; submitting DOT Plot from me not helpful for setting policy… I think that markets perform best when reacting to incoming data; they work less efficiently when they ask how will the Fed react to that incoming information.”
(Graham’s note: the days of forward guidance from the Fed are ending. Going forward the Fed will be simply stating facts and not hypothesizing).
“Most data we have is from old-fashioned survey methods… and the Fed needs to decide what’s good data and what’s bad data… what is the real economy doing.”
(Graham’s note: Warsh is aware of what I’ve been screaming about for decades, namely that economic data in the U.S. is garbage).
“Inflation is mainly determined by Fed policy… [we] don’t believe in cruel choice between jobs and inflation… We have work to do on price stability… Fed credibility depends on delivering on what we say we will do.”
(Graham’s note: The new Fed Chair understands that the Phillips curve (more on this shortly) is bogus and that the Fed needs to act, not grandstand).
In the span of about 45 minutes, Kevin Warsh decimated ~50 years of Fed policy mistakes and sent a clear signal that the era of pontificating based on garbage data is over. Most importantly, Warsh indicated that he views the Phillips Curve to be nonsense. This is fantastic as the Phillips curve has been the basis of most major Fed policy mistakes.
The Phillips Curve was developed by New Zealand economist William Phillips in the late 1950s. In its simplest rendering, it stated that there was an inverse relationship between unemployment and inflation — when unemployment is low, wage and price pressures rise; when unemployment is high, inflation tends to ease.
The stagflation of the 1970s proved this to be total nonsense… but that hasn’t stopped the Fed from using this economic framework for the last 50 years. Indeed, this line of thinking is partially responsible for the Greenspan Fed creating the Tech Bubble (Greenspan claimed inflation didn’t exist and so it was safe to cut rates in 1996). It’s also why the Fed created an inflationary storm from 2010-2011 (Bernanke believed that high unemployment meant inflation couldn’t appear and so the Fed needed to keep printing hundreds of billions of dollars. Finally, this reasoning was why the Fed argued that inflation was “transitory” throughout 2021-2022 (if the economy was weak and unemployment was high, inflation wouldn’t appear).
Again, what Kevin Warsh did yesterday could easily comprise an entire book. But for our purposes we need to understand that there is a revolution taking place at the Fed.
In bullet forms:
- The Fed will be reworking how it measures inflation and other metrics.
- The Fed will be assessing what data is useful vs. what is useless.
- The Fed will no longer be issuing “forward guidance” to manipulate the markets.
- The Fed will no longer be issuing verbal statements unless necessary.
In short, we are in a new era, of data-driven, unassuming Fed policy. For anyone who’s despised how the Fed has done things over the last three decades (me included) this is fantastic news. Obviously, these changes won’t take place overnight. But the repugnant era of Fed officials shamelessly issuing moronic statements is finally coming to an end.
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Best Regards
Graham Summers, MBA
Chief Market Strategist
Phoenix Capital Research