US Fed Chair Warsh Takes the Mic

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1:43Bloomberg Audio Studios. Podcasts, radio, news. Warsh said he described his Jackson Hole speech as, quote, a blank piece of paper. Does that mean he's just going to wing it or just that he doesn't yet know what he's going to share? I assume he meant he doesn't yet know. In true keeping to his own values, he won't even give forward guidance about what he is going to talk about. I'm Sarah Holder, and this is The Big Take from Bloomberg News. Joe Weisenthal, the co-host of the Odd Lots podcast, joins me today on what to expect from Kevin Worsh's first major speech as the chairman of the U.S. Federal Reserve as he grapples with the pressures of politics and rising yields.

2:35So, Joe, you're headed to Jackson Hole, Wyoming this week for the annual Kansas City Fed Conference. This year, there's this one major thing to look out for, which is Kevin Worsh's first Jackson Hole speech as Fed chair, which he'll give tomorrow, Friday. There's no requirement for what it's worth that the Federal Reserve chair has to show up there. But typically, the Fed chair shows up. Historically speaking, over the last like 15 years or so, it has been a site where big speeches, big broader speeches are delivered. This speech is going to represent where our heads at as central bankers. What should we be thinking about?

3:09A pulse check on the economy from one of the most important economic figures in the country. And so Kevin Worsh, he hasn't really shown his cards in terms of how he thinks the interaction of monetary policy in the economy is right now. He's had two press conferences as Fed chair. He doesn't say much about that. By design, right? By design. That's his whole thing. That's his style. Then there is the fact that, you know, rates have been shooting up. Inflation continues to be above target. So it's one thing to say, as he said, that we've got to get inflation down. But unless you like do something about it, talk about it, doesn't matter.

3:43And then there is all the work that he's done in terms of just sort of rethinking how the Fed operates. So the question is, is he going to tell us something new about how he thinks the Fed should be operating? Some sort of like new guiding principles, some new changes in direction? or is he going to give a speech that is kind of like, all right, now let me tell you what I think we should be doing right now over the next several meetings to close the gap between where inflation is versus where we want it to be. Whatever he says might be weird because if he started talking very much about like, this is where I think the economy is, this is the prescription I think it needs, that would be a departure.

4:22But if he gave a speech kind of like his press conferences, which have just been like, I'll get back. Nothing burger. Yeah, he really hasn't said much. That would be a weird venue to deliver there. So it's a big wild card to me. I don't think anyone really knows. Yeah, Kevin Worsh has been pretty clear that he wants to approach the Fed chair job differently than his predecessors. He's not into forward guidance. That's right. He's in favor of the Fed communicating less and wants markets basically to do the talking. How has his strategy been working so far and why has his approach been so unsettling to some?

4:52He makes some points that people should take seriously about how the Fed communicates. So I mentioned that like at his press conferences, he doesn't really say much about his plans. But like this is like a very novel innovation by the Fed to have press conferences in the first place. Alan Greenspan wasn't doing press conferences and there was much less Fed chatter generally. So like one could certainly make the argument that some of these new approaches to communication, which really accelerated after the financial crisis, have outlived their usefulness. And, you know, when he talks about his dislike of forward guidance, the dot plot is a tool to express forward guidance.

5:35All the members of the FOMC saying, basically, this is where we think the economy is going, and this would be the appropriate trajectory of policy in order to get us. And people salivate over those dot plots. Yeah, and it's all pretty new, though. Other central banks don't have dot plots. Like, None of these things are like set in stone. What I think unsettles people with Kevin Walsh is we don't have any real idea yet about how he perceives the relationship between the Fed's toolkit and how it can be used to accomplish the Fed's dual mandate. And the dual mandate being keep inflation down. Keep inflation down and keep employment.

6:12Keep the job market humming. So people talk about the Fed's so-called reaction function. And this is, I think, what the market really wants to know. They want to understand, OK, let's say the next CPI print or the next PCE print comes in significantly hotter than expected. If you have an understanding of how the Fed operates, you can infer what that will mean for policy. So it's like, OK, if we get inflation running above target for this and unemployment stays very low, then we can infer that this likely would be an environment that calls for higher rates. Right. Not what decision Kevin Warsh and the Fed is going to make, but how they make those decisions.

6:53Yeah, exactly that. How they are metabolizing the incoming data and how that will translate into policy changes. But it changes over time. And this is important. Like, there's no, like, fixed, correct reaction function. The part that is perceived to be unsettling so far under Kevin Warsh is people just do not feel like they have any understanding of how he's thinking about the data, the goals, and the tools that they have to meet their goals. So Kevin Warsh talks a lot about, in the absence, at least for now, of that reaction function and explanation around that reaction function, look at the markets.

7:27So what signals have the markets been sending? This is a really important question, and it gets to something that I've been frustrated by the look at the markets line. What is the government bond market? Let's say we talk about what does the yield on the two-year bond mean at any given point. Yes. What does that mean? Well, the two-year yield is arguably, and actually most people would agree with this part, is the average overnight rate, the market's expectation of the overnight rate every day for the next two years. The long run is a series of short runs, is how to think about it, or at least how I think about it.

8:08A lot of people think about it. And so what is a 10-year rate? Well, arguably, that is the market's expectation for the Fed's overnight interest rate, what it's going to average over the next 10 years. And so one way to interpret when we see bond yields rising is this is the market saying, given what we know about inflation and given what we know about how the Fed is going to react to inflation, we expect rates to be higher in order for the central bank to meet its goals. As I see it, there is essentially no such thing as a pure market signal because ultimately it's the market making a bet on what you're going to be doing.

8:49There's 12 members of the Federal Reserve. There's a handful of voting members each time. The market is trying to anticipate what they're going to be doing. The idea of, quote, playing the ball, not the ref, is kind of strange to me because it is a game of betting on what the Fed is going to do. Right. So the market signals that we're getting are influenced by the Fed's action or inaction or potential action. And not only that, they can't not be. There is nothing else for the market to bet on. Well, I want to talk about this moment for the bond market because I'm wondering about what higher yields actually mean for the Fed.

9:23Because Kevin Warsh back in July sort of indicated that, you know, he's watching the bond market. He sees these high yields. He implied that they could help get inflation under control without the Fed's intervention. So how does Warsh read high yields? You know, I don't know. Like I really I genuinely don't know the answer to this because he's given sort of multiple indications. When rates were going down earlier in the year, he interpreted that as the market is optimistic that inflation is coming down. And this is a very good sign for us. Then when long-end rates started spiking over the last several weeks, then the switch turned to the market is sort of doing its work for us.

10:08But that's something different. Like those two statements are not symmetrical. A way to interpret what the market has been doing lately is this Fed does not seem very aggressive about getting inflation down right now. So that's when you get your decline at the two-year rate, OK? But then a Fed that's not particularly aggressive about getting inflation down right now might also be a Fed that ultimately has a bigger inflation problem on its hands in the future. And will have to act more aggressively. And will have to act more aggressively. And that's how you get the higher rate at the long end of the curve.

10:41And so, yes, at every level of the curve, it is some imputed prediction about what the Fed will ultimately be forced to do. But then there's this other wrinkle here, which is the actions of Treasury Secretary Scott Besant, who has been buying up these long-term bonds in response to these higher yields. Why is he doing this, and what effect has it been having? I think there is something about seeing high rates blow out at the very long end of the curve that people find to be, like, unsettling. Clearly, the Treasury has in its capacity to shift the composition of bonds at issues. So it could issue more at the two-year level and use those proceeds to buy to depress 30-year rates.

11:25But when you're like buying at the long end of the curve to depress that rate, you are essentially engaged in what they call yield curve control, which was famously used by the Bank of Japan for years as it tried to get out of its disinflationary or deflationary slump, which is just let's just smash that long end down. Let's pin that rate low. And hopefully this catalyzes a sort of like reinflationary element. Rates are lower. Great. hey, we're going to invest more. We're going to buy a house. We're going to do all that stuff that comes in theory with lower rates, which is fine. But that could increase inflation, right?

12:04Right. That's exactly it. Like that is not the common playbook for when your main problem is running above target. So I think a lot of people look at this and see it as a case of literally like treating the symptom rather than what ails the economy. What ails the economy? Well, one thing that allows the economy right now is that inflation remains above target and is not expected to get back to its target anytime soon on a sustainable basis. Okay, so let me try to reflect this back at you. Basically, higher yields are indicating an inflationary environment. Yes. Treasury Secretary Scott Besant buying up these longer-term bonds in an effort to bring yields down, which could spike inflation.

12:47Yes, that's right. It's literally that, right? Like you look at, you know, any sort of economic activity, whether it's buying a house or building a new factory, in theory, one of the things you would look at is, well, like how much money can I make on this investment? How much is it worth to me? Is it worth it once I factor in how much I have to borrow in order to do this, right? And so in theory, high rates have some sort of cooling effect on the economy because it's like, oh, you know what? This project yields 10%. I have to borrow at 7%. I don't know. It's like, is it really worth it for this 3 % yield pickup?

13:24Maybe not. And so it's like, all right, we're going to like stop that factory project or stop that or maybe not buy a house, whatever, et cetera. And so that is how you get your cooling effect. There's less economic activity. the employment market softens, supply chains, slack emerges, and so forth. This is just like that's sort of the basic one-on-one idea here of how the interest rate channel affects the economy. So if you're like suppressing that rate, then in theory, suddenly a lot more economic activity becomes attractive, right? That's a weird thing to sort of push for if you say that our primary concern right now is that inflation remains too high.

14:05Right. So if hypothetically Besson's interventions work to lower yields, that might mean that the Fed would be under more pressure to use other means to fight inflation. Yeah, it creates two different issues. One is that might ultimately create more pressure on the Fed. OK, inflation starts to warm up again because rates have been depressed by the Treasury. So A, that might put more pressure on the Fed to hike rates more aggressively. and B, it just totally gives light to the idea that there is some ball out there that's not playing the ref, right? So I would be curious, he's not going to come up with a Jackson Hole speech, but maybe he'll be asked about it at his next press conference, is like, you say, Chairman Walsh, that you take signals from the bond market, etc.

14:53Are these signals any good anymore when we see a Treasury that is sort of engaging in active efforts to shape the old curve? is this even a market signal anymore that's of value to you? Coming up, how Warsh might try to reassure markets at Jackson Hole, and whether an independent central bank will remain a priority moving forward.

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17:36So Orsch has a lot riding on this Jackson Hole speech. He's got to soothe markets. He's got to assure people that the Fed has a plan to get inflation in check. How is he going to thread that needle? Yeah, I think it actually might even be more complicated than that because he's new on the FOMC. He wants to come off to the other voting members at any given time as being, like, credible, right? And so he also has, like, an internal argument to make. Like, I think that, like, he can only leave these big questions unanswered for so long. The three predecessors, Powell, Yellen, and Bernanke, were very consensus building on the FOMC.

18:19That is like, OK, this is where we're going and this is the case. Consensus is probably fairly important for any strategy. You know, you could like pass a rate hike on a very narrow like five to four basis. But then the market will question. It's like, well, are they going to continue with this? Is this a Fed that's actually committed to getting inflation down? Whatever it is, if it's too narrow. And we have been seeing new signs of dissent. There have been a lot of dissents. Under Warsh, right? So this is the other thing. So there are, A, like there were people at the last decision who voted that there should have been a rate hike at the last meeting.

18:52But we've gotten a lot of speeches from other Fed governors basically saying, like, if inflation doesn't come down soon, we're going to have to hike rates even more aggressively than we expected. So the other issue for Warsh is he has to like whatever his plan is, whether he wants to hold rates steady, whether he wants to hike them two times, three times, we don't know, to build that credibility up. Look, he's come into the job during a wide period where there's been suspicion that it's like, oh, is he going to be setting monetary policy at the behest of the White House? Right, because Trump, of course, wants rates to come down.

19:29Yeah, exactly. So is this a Fed chair who is, like, doing political bidding on behalf of the White House? And it's not just credibility among members of the FOMC, right? It's the public. It's economists. Like, I was, you know, reading this piece in the FT, and there are a lot of experts who are basically saying, like, if the Fed loses credibility, that has economic impacts. If he's not providing clarity, that could provoke unnecessary speculation. Like, all of that also has a ripple effect. I mean, there's uncertainty all the way down. Can the Fed as a quasi-independent institution, can it continue to exist in this political climate?

20:08Does the political muscle exist in the U.S. and elsewhere to maintain this entity that's outside of direct democratic control? Do we have this sort of like restraint to not do that? Or will at some point our politicians, our presidents, and so forth just say like, no, this should all just be our job. And we will direct spending or we will direct lending. We will set the interest rate based on what we want. What would the consequences of something like that be? You would assume that that would be a lot more inflationary environment because it's hardly ever popular to cut spending. It's almost always popular to cut taxes and so forth.

20:47So one would assume that an economic policy-making body that's under the control of elected officials would be very reluctant to tighten policy if that's what's called for at a given time. I mean, it's already come up with the fights over the FTC and the FCC. Congress built those institutions with the idea that there should be certain things that are not under direct control by either Congress or the president. We know that that's gone, right, because the Supreme Court ruled that the president can fire agency members, commissioners at his will. The Fed, at least for now, on paper, it's actually a little ambiguous.

21:29It's not settled, but at least for now, the president does not have the ability to fire a Fed governor. So far, the White House does not have the ability to influence rates directly. But A, like they're trying to, and B, we actually kind of are seeing it with the Treasury and these bond buybacks. So whether the appetite persists to just even have this body of unelected people setting interest rates, I think it's a very open question.

21:59This is The Big Take from Bloomberg News. I'm Sarah Holder. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. If you like this episode, make sure to follow and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.

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