Key Takeaways
- As speculation builds around a Warsh-led Federal Reserve, the prospect of eliminating the ‘dot plot’ could mark a major shift in forward guidance—potentially increasing rate volatility and reshaping how fixed income markets price policy risk.
- While the Fed’s communication toolkit has steadily expanded since 2000—from formal post-meeting statements to press conferences and quarterly projections—a deliberate rollback of forward guidance could reduce policy transparency but also curb market misinterpretations that have plagued rate forecasts.
- With less explicit guidance likely to amplify uncertainty at the back end of the yield curve, investors may consider WisdomTree’s active-passive fixed income barbell approach to help balance duration risk and policy surprises in a potentially more volatile rate environment.
This will be the third and final installment of my discussion regarding the potential for a Federal Reserve that will be led by current nominee, Kevin Warsh. As I’ve discussed in my prior two blogs and podcasts, the potential hallmark of any Warsh-led Fed could be the reduction of the Fed’s ‘footprint’. Last week we addressed the balance sheet part of the equation, but for this edition, I’d like to weigh in on the other aspect of a reduced footprint, forward guidance.
Forms of Forward Guidance
Forward guidance comes from a variety of avenues. Below are some of the current forms:
- ‘Fed-speak’, or Fed officials’ public appearances, such as Congressional testimonies and speeches
- The Semiannual Monetary Policy Report to Congress
- The Federal Open Market Committee (FOMC) meeting policy statement
- The quarterly Summary of Economic Projections (SEP), which includes the ‘dot plot’ (Fed’s projections for the fed funds rate)
- The post-FOMC meeting Fed chair’s press conference
A Brief History Lesson
For the financial markets and investors, it has become commonplace for the Fed to be rather ‘open’ in their communication to the public. However, history shows these lines of communication are relatively new in the context of monetary policy history, and how in the past, the Fed was far from being an ‘open book’.
- In January 2000, the FOMC announced that it would issue a policy statement following each meeting regardless of whether there had been a change in monetary policy.
- Prior to 2007, the only ‘official’ communication from the Fed in which markets and investors could see policymakers’ economic projections came in 1979 from the Fed Chair’s Humphrey-Hawkins testimony/report. That is now known as the Semiannual Monetary Policy Report to Congress.
- In late 2007, the FOMC began expanding the content and frequency of its economic projections, ultimately leading to the aforementioned quarterly SEP.
- In 2011, quarterly (now eight) press conferences began after each post-FOMC meeting .
- In 2012, the ‘dot plot’ made its first appearance.
What Could a Smaller Footprint Look Like?
Given the various forms of forward guidance, it appears as if a Chairman Warsh could consider a range of options if the plan is to reduce this ‘footprint’. It is unclear whether limits could be placed on speeches or appearances per se from the governors and bank presidents, but perhaps, a new ‘rule’ could be implemented where outright individual monetary policy opinions are discouraged. Congressional testimonies could be an exception to the rule, but that’s usually the domain of the Fed Chair anyway.
Believe it or not, in terms of the policy statement, prior to 1995, the Fed did not actually provide a post-FOMC meeting statement on whether any changes were made to rates. The markets had to determine the outcome based upon the Fed’s daily open market operations. This form of guidance more than likely remains. Along the same lines, the post-FOMC presser could also ‘make the cut’. This ritual is also followed by other developed world central banks.
Now comes the interesting part, the SEP. While Fed economic projections could remain, one could arguably make the case that a ‘footprint reduction’ would entail eliminating the dot plot. The dot-plot has probably created the most confusion for the money and bond markets because its projections have often diverged from actual Fed rate moves.
Conclusion
Interestingly enough, sometimes too much Fed communication has also led to market misinterpretations. That being said, reduced Fed communications would more than likely result in increased volatility, especially for the back-end of the curve, as less forward guidance could create a void and potentially result in policy surprises.
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