What Is Fed Chair Kevin Warsh Trying to Say?

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1:33Stephanie Flanders:I'm Stephanie Flanders, Head of Government and Economics at Bloomberg, and this is Trumponomics, the podcast that looks at pretty much everything in the economic world of Donald Trump. And in that world, the US Central Bank looms pretty large, and now Donald Trump's hand-picked Fed chair, Kevin Walsh, has been in the job nearly three months, I thought it was worth taking stock of his tenure so far. We're recording this on Wednesday morning, US time, so we also have just had a new US inflation number that could make his job slightly easier. One big headline about Kevin Walsh's time at the helm so far, he's been his own man.

2:11Stephanie Flanders:Despite all the politics around his selection, he's not actively been trying to persuade his fellow governors to cut interest rates, as Donald Trump had urged so often. And although the president says they've spoken, Walsh doesn't appear to be taking regular cues from the White House. Which probably also note that he's not made any clear gaffes. Most incoming Fed chairs have had a misstep or two in their first few weeks. They've been caught thinking aloud in an interview or said a bit too much at a press conference. Well, that's not Chair Walsh. In fact, he's not been saying very much at all about anything.

2:46Stephanie Flanders:and that is a big change for the financial markets after years in which policymakers have become used to offering a lot of guidance and transparency around their decision-making. It's left a lot of people, inside and outside the financial markets, unhappy and confused. Now, you could say investors could just grow up and learn to live with less spoon-feeding, but for some, including Bloomberg opinion columnist and former New York Federal Reserve President Bill Dudley, the issue runs deeper than a change of comms. And I'm glad to say he's with us on Trumponomics to explain. Bill, thank you very much.

3:21Yes, I'm delighted to be here.

3:23Stephanie Flanders:Now, it's quite difficult these days to find wholehearted supporters of the approach Kevin Walsh has taken, but Robin Brooks is one who thinks the world has maybe been a bit too tough on him. And you'll remember he was on the show a while back, is now a blogger, senior fellow at the Brookings Institution, former chief economist for the Institute for International Finance and chief FX strategist at Goldman Sachs. Robin, thanks for coming back. Thanks for having me.

3:56Stephanie Flanders:We are speaking just an hour or so after the CPI, Consumer Price Index, numbers come out for the US. And so I guess we should spend a couple of minutes on that, given that it looms quite large in a lot of this decision making. we saw the core inflation number at 2.5 % annual rate. That's the lowest in more than five years. The headline rate, 3.4%, a fair bit higher as it has been for a while. Bill, just briefly on this, how do you think it changes the outlook, if at all, for the next few months to have this number? It wasn't a big surprise, it has to be said. I think it doesn't change it very much.

4:35I think the Fed was on hold at the last meeting because they thought the inflation data was going to be more benign. It has been more benign. So all the arguments for staying on hold that you had at the last meeting are still in place. And that's why the market reduced its probability of tightening in September from about 60 % to about 45%. But there's a long way to go to the next meeting. I think fundamentally the arguments for tightening are still pretty strong. The arguments I would make is, number one, it doesn't look like monetary policy is actually restrictive. We've been at this interest rate or higher for two years, and we're still operating at full employment.

5:11Number two, we're missing more on the inflation mandate than we are on the employment mandate. So in terms of which side you want to care about, you'd care more about the inflation side. And especially in the fact that we've missed the inflation objective for five years in a row. And then lastly, the risk of error here, I think, is asymmetric as well. If you tighten it, it turns out to be unnecessary. You can obviously easily reverse it. If you don't tighten and you should have tightened, then you have a risk of inflation expectations becoming unanchored. And you have to believe that's a real risk given that the Fed has missed for five years in a row.

5:42Stephanie Flanders:We hear that argument a lot, although not so much from Kevin Walsh. Robin, just on this July inflation number. So I would say that I came into this number with a fairly strong view that we don't, even though we've had many years of various supply shocks, and of course they just keep coming, We don't really have a picture where inflation is broadening out. I regularly put out in my Substack data on inflation generalization, so things that measure the combined weight of items in the CPI and the PCE that are above 2%. And those things have been trending down for a couple of years. So I came into this print constructively.

6:27If you look at the guts of this print, then I totally agree with Bill. The guts are quite benign. In particular, if you look at what I sort of think of as core core. So when you strip out the noisy elements of core inflation, because core does contain non-market stuff like OER, administered prices. When you strip that stuff out, basically we had an inflation reading that was flat. after a slightly negative reading a month ago. So my views on monetary policy here have been heavily predicated on what's going on with inflation. And I just don't think from my perspective, this is a print that screams for tightening.

7:14Stephanie Flanders:I think that's where it leaves us. And both of you are in a slightly different place, but I think we're at least saying there's more question marks around an interest rate rise in September. And I think that's kind of broadly reflected in the market pricing. But obviously, we're in a quite different place than we might have been six months ago when there was much more of a live discussion around cutting interest rates. Even in the discussion we've just had, you've said a great deal more than Kevin Walsh has been willing to say about the underlying dynamics for inflation or what might drive policy going forward.

7:46Stephanie Flanders:So, Bill, explain why you think that lack of communications is a problem. So I have no problem with getting rid of forward guidance. I think forward guidance, talking about what you're going to do next, is a bad idea because basically it can constrain you from changing policy when new information comes along that suggests that a change is warranted and it can sort of lock you in. We kind of got in the habit of doing that after the global financial crisis. It was sort of somewhat controversial, but then a lot of central banks ended up having, once you start doing it, it has been quite hard for central banks to step back from it.

8:21And you could argue that the Fed's policy or going through the COVID pandemic was the fact that they were sort of locked in with all these conditions about what would have to happen before they would actually raise rates. If you remember, they couldn't raise rates until we were at full employment, until inflation was at 2 percent. And we thought inflation was going to be above 2 percent in the future. So in March of 22, inflation was really high and the federal funds rate was at zero. So that was an example of four kinds of really boxing you in. So I think most economists, I think, agree with the predicate that Ford guidance is too constraining.

8:54But we can't conflate Ford guidance with providing information about the Fed's monetary policy reaction function. In other words, how does the Fed think about monetary policy? How does the Fed think how monetary policy affects aggregate demand and inflation? And Kevin Warch has been very reluctant to provide any information about how he's thinking about the economy and what the implications of that are for monetary policy. And I think that's a mistake. You know, he basically wants to outsource it to financial markets to sort of decide what the Fed should do. But the markets don't price to what the Fed should do.

9:25They price to what the Fed will do. And so in this situation, you just have the markets looking at the Fed, the Fed looking at the markets, and policy becomes sort of indeterminate. So I think this is a mistake not to provide more information about how you're thinking about monetary policy. And it's partly about credibility and accountability. If the Fed's a complete black box, then the Fed is actually not being very accountable in terms of its responsibilities to the public.

9:49Stephanie Flanders:Robin, I think lots of people agree that it's constraining to have the forward guidance, especially the kind of super detailed conditionality around future policy. But we've got used to having a pretty clear idea of what central bank's reaction function is, you know, how it will respond to a given set of circumstances. It seems like Kevin Walsh doesn't even want to provide much clarity on that. First of all, I should say that I've only ever worked as a central bank as an intern. So I definitely am way more junior in that respect to Bill. I can't hold the candle to President of the New York Fed.

10:26So I thought I would give a little bit of market perspective on everything. And I think the number one question is there is clearly mounting political pressure on the Fed. And that predates Warsh. And it predates some of the, I think, communication lapses in the recent press conferences that he's done. And to be fair to Warsh, I don't think his performance was great. I think he's being too glib about batting off questions about the outlook. I don't love it. But let's give the guy a little bit of a break. The initial press conferences of his predecessors weren't exactly a march of glory either.

11:11So there's a learning curve. It's a massive job. There's nerves. So I would say that. I think the bigger issue is this growing pressure on the Fed and other central banks. And roll the clock back exactly one year, Stephanie, to Jackson Hole 2025. Powell gave a speech on the 22nd of August where he basically said, you know what, the balances of inflation versus employment are tilting in favor of worrying about employment and we're going to start easing. This came after months of criticism by the president. It came immediately after criticism a few days before where Trump said Powell is terrible for the housing market.

11:59And if you look at financial markets, there's a lot of talk how the curve has steepened now, right? The long-term yields have risen because markets are worried about inflation and risk premium and volatility. Well, guess what? The curve steepened just as much after that August 22nd, 2025 dovish speech from Powell. And if you look at precious metals prices back then, you know, that was the debasement trade. Gold, silver, all these crazy things went completely bonkers. So the first point that I want to make is I think it's a bit of a red herring to personalize this too much. I think, obviously, Warsh is Warsh, and he's new.

12:42And there are a lot of questions given how little he's saying. But I think the bigger issue is that we have a Fed that's under massive pressure from politicians. And the underlying problem is that fiscal policy is completely out of control, and we have real worries about how we're going to pay for all this debt. So I think that's my number one point. On the specifics of forward guidance that Bill mentioned, so I totally agree. there is no right formula for the right amount of forward guidance. The only thing that I would say, you can look at how data-sensitive treasury yields are. And ideally, you want the market to incorporate information actively and to have a high beta to what's going on.

13:27This is basically what Warsh is saying, right? He's saying, I want the market to form its own view. And we are, if you look at history, about on a two out of 10 on that scale. So the data sensitivity of treasury yields, whether you look at two-year or 10-year, is very low. So that means that markets here are still very complacent about the role that they are supposed to play in this regime change. And so I take some of the rhetoric about loss of credibility with a big grain of salt because of that. Can I just push back a little bit on that? I think that where I would disagree a little bit is it's not like Worsh came in and said everything is fine.

14:10No, he talked about regime change. So, you know, I think he's getting more criticism because he's actually promised that he's going to do things totally differently. And yet hasn't really explained why this totally different way of doing things is necessarily going to lead to better outcomes. So I think the problem for Kevin so far has been a little bit of all had no cattle. I mean, he's promised a lot, but he hasn't really delivered anything. I mean, we're waiting for the task forces and the task forces aren't going to arrive for another, you know, four or five months. And even then, I mean, who knows what the task forces are going to come up with this.

14:41As Chris Waller pointed out, you know, it's not like these issues haven't already been studied pretty intensively within the Fed. So I think that Kevin has basically raised the stakes. and when you underperform after raising the stakes, then I think you're going to be more subject to criticism.

14:55Stephanie Flanders:The task forces, I guess, they're on the framework for policy, the balance sheet, financial market functioning, communications. I'm trying to remember. Inflation. Inflation, yeah. Which, as you say, all of those things have been discussed at length.

15:22Stephanie Flanders:Sticking with you, Bill, for a bit, there's an element of this which is about giving a new chair time to bed in. But I think there's also a specific thing, which I guess is your point, which is if you don't give any clarity on your underlying model for the economy, or you seem to suggest that you're putting it all onto the market itself, then that is what over time causes a credibility problem, not necessarily today or tomorrow, but over time. And is also, there's sort of a, there is a coherency problem there because it comes to seem very circular. You know, everything is based on either what the markets are saying or what expectations are saying.

16:04Stephanie Flanders:And somehow the central bank becomes almost like on, you know, left out of the picture. The way I think about it is that the monetary policy in the U.S. works very powerfully through financial conditions. So what the Fed does affects the bond market, the stock market, the dollar, credit spreads, et cetera. The impulse from short-term rates to the real economy directly is pretty mild. And so you really want financial conditions to sort of get it right about what the Fed is actually going to do, because if financial conditions get it right, financial markets can price the data in real time to what the Fed will actually likely do in the future.

16:36That makes monetary policy more efficient, and it also makes it more timely. But if you're basically throwing a lot of dust into the air and confusing markets about what the Fed is actually going to do that transmission between the data determining market expectations versus what the Fed will actually do becomes a lot more loose. And that basically makes monetary policy less effective. So I've been an advocate of transparency for a very long time. But transparency doesn't mean forward guidance. And I think we have to distinguish between those two different things.

17:08Stephanie Flanders:Robin, as you say, you were a market participant in his press conference when Kevin Walsh was emphasizing that he kept referring to the market, kept referring to bond yields. It wasn't clear to a lot of people whether he was suggesting that that higher level of bond market of yields, of long-term yields, was suggesting that rates needed to be higher over time, or that the bond market was doing the tightening for the Fed. I just wonder, how did you read that? Because that was one of the bits that sort of was confusing to people and sounded very circular. Yeah, I don't think that was a strong point of the press conference.

17:44But go back to 2013 and the taper tantrum. You know, the situation to me as an outsider at the time I was sitting on the trading floor at Goldman, you know, the 10-year yield was around 1.5%. It was very stable. Financial conditions were very easy. and we then had congressional testimony from Bernanke in May 2013 that said, you know, we may taper QE3. QE3 was running at the time. And this was a big shock because it pulled the rug out from what markets thought was a certain environment. And of course, the dividing line there between transparency and forward guidance is a hard one to draw. Because, you know, when are they going to taper?

18:40How much? It's actually really hard to say.

18:43Stephanie Flanders:But if you're clear about your reaction function, I don't think that is the same as forward guidance. Yeah, I guess. But things start to get specific real fast. And I think it's hard to be specific. And so in a way, you can't be. So if you are a central bank that is going to provide less information and let the market do more heavy lifting, then it means there will be more surprises to markets. They won't like that. And it will lead to more volatility and curve steepening. That's exactly what happened in 2013. And that's what we're seeing now. Is that a negative indictment on Warsh? I'm not sure.

19:27Yeah.

19:27Stephanie Flanders:Bill, in a deeper sense, is it too soon to say at the time he may end up saying a bit more in press conferences? And at some level, he was kind of making a point in his first press conference. But for example, in the Jackson Hole speech coming up, he's kind of said he thinks of it as a blank sheet. It won't go down very well if it is a blank sheet. But if he gives a kind of pretty standard speech where he does flesh a bit more out like his kind of broader thinking about the economy. I mean, this is all recoverable, presumably. Yeah. I mean, what I expect is not Kevin Walsh to come up and say, oh, I did it wrong and I'm going to change and I'm going to give you a lot more information going forward.

20:03I think what's going to happen is he's just going to gradually give more information because more information is the appropriate way to respond. The fact is, if he doesn't give information to the market, people are just going to turn to other Fed speakers for that information. It's not as if other Fed officials aren't telling you about what their monetary policy reaction function is. And so I think from Kevin Walsh's perspective, He needs to talk more also so that he's the one that people actually listen to about what the Fed is likely to do in the future.

20:30Stephanie Flanders:Who gets this right? I mean, I'm sort of thinking about at the Bank of England, we've had the sort of opposite extreme now where everybody is now, they get their own separate paragraph in the minutes or even in the statement about the interest rate decision. massive influx of speaking from and views from all the individual members, which some think of as just being a cacophony and not being very helpful. The European Central Bank, you've always had a cacophony in terms of all the governors from all these countries that you can't really control. But the messaging of the leadership has been reasonably clear about we look at these three things when we're thinking about how to change policy.

21:10Stephanie Flanders:Do you think either the Bank of England or the ECB is getting us more right? I like the ECB's approach because I think what they're doing is they're saying, here's our baseline forecast, the staff forecast, and then there are scenarios around that. So there's alternative scenarios. And I think providing alternative scenarios gives you a notion of if things evolve differently than our baseline forecast, here's how we're likely to respond. And having the alternative scenarios gives market information about how the central bankers likely react if things turn out differently than the central bank has forecast.