Since taking office, Federal Reserve Chair Kevin Warsh has acted with extreme caution to avoid signaling the direction of interest rates, but in doing so has obscured another piece of information critical to investors, analysts, and other policymakers alike—how he would respond to economic challenges.
Zhitong Finance APP reported that since taking office, Federal Reserve Chair Kevin Warsh has acted with extreme caution to avoid signaling the future direction of interest rates, but in doing so has obscured another piece of information critical to investors, analysts, and other policymakers alike—how he would respond to economic challenges.
Warsh will appear before congressional hearings on Tuesday and Wednesday, where Fed watchers will closely monitor his views on inflation, the labor market, and economic growth—and how these factors interact with interest rates. However, if recent public appearances are any indication, observers may again come away with little clarity.
Warsh has pledged to abandon the central bank’s so-called “forward guidance”—that is, signals about the interest rate path. At his first press conference on June 17, he avoided answering multiple related questions. For instance, when asked how patient policymakers could be while waiting for inflation to subside, he responded: “Your question sounds like you’re encouraging me to provide forward guidance.”
This has fueled mounting frustration outside the Fed, with one of Warsh’s influential colleagues speaking out publicly on the matter. Last week in Rome, Federal Reserve Governor Christopher Waller explicitly distinguished between “providing forward guidance” and “explaining how the central bank might respond under different economic scenarios.” He noted that the latter helps reduce uncertainty for markets and households, making “everyone’s lives a bit easier.”
“Reaction function”
Aside from “forward guidance,” another frequently used term is “reaction function”—a phrase employed by Waller and several other economists. This somewhat obscure term lies at the heart of the current debate. Economists stress that clarifying the distinction between these two concepts is crucial.
As economist Andrew Sacher explained: “Forward guidance tells the market which path the central bank believes it will take; a reaction function tells the market how the central bank will respond to unexpected developments, without revealing its expected path.”
Many, including Waller, acknowledge that Warsh has a valid point: excessive forward guidance can constrain policymakers by creating the impression that they have already committed to future interest rate decisions. However, failing to clarify his reaction function could likewise entail significant risks.
Pricing in financial markets—particularly key benchmarks such as the 10-year U.S. Treasury yield or the Secured Overnight Financing Rate (SOFR)—partly depends on investors’ expectations of future central bank behavior. If the market clearly understands the central bank’s logic, participants can incorporate their own economic forecasts to form reasonable judgments about the interest rate trajectory. This, in turn, helps mitigate market volatility when forecasts are broadly accurate and can even shorten the time it takes for interest rate changes to transmit through to the real economy.
“Effective communication conveys the Fed’s reaction function—the relationship between economic conditions and the policy rate path. That’s the real core issue,” said Richard Berner, a professor at New York University who served on the Federal Reserve’s research staff in the 1970s. “It’s entirely different from forward guidance.”
A Federal Reserve spokesperson declined to comment on the matter.
cede the initiative
Facing criticism that the Fed’s communication lacked clarity, Waller rebutted the claim on July 1 in Portugal, citing the bond market as an example while appearing alongside other central bank governors.
“Volatility hasn’t risen—it has actually declined,” he said. “People keep saying the policy is unclear, but in my view, the market understands it very well.”
However, this view has not been widely shared. Michael Feroli, chief U.S. economist at JPMorgan, stated that if Waller continues to remain silent, he risks ceding the Fed’s communication leadership to other policymakers.
“He has yet to demonstrate any command over the current economic situation,” Feroli said. “We are left with no choice but to turn to other Fed officials to understand their interpretation of the economy.”
Waller’s approach extends beyond public remarks. In June, when policymakers submitted their quarterly economic projections and interest rate expectations—commonly known as the “dot plot”—he opted not to participate. The post-meeting statement was notably shorter, and the minutes released three weeks later were also more concise than usual.
Nevertheless, the minutes from the June interest rate meeting indicated that Waller received support for shortening the post-meeting statement, with some participants welcoming a reassessment of the Fed’s communication approach. Other officials have recently suggested that, given heightened economic uncertainty, it may be necessary to scale back forward guidance provided to investors.
However, if this strategy obscures the framework through which the Fed interprets and responds to economic conditions, such support could gradually erode. Speaking in Rome, Waller emphasized that maintaining clarity about the reaction function is “one of the key lessons” drawn from three decades of central banking practice.
Lessons from the past
Lou Crandall, chief economist at Wrightson ICAP, entered the field in the 1980s and recalls that the Federal Reserve did not even announce its interest rate decisions at the time. “It was complete chaos,” he said.
Then-Chairman Alan Greenspan—whom Waller mentioned during his swearing-in ceremony—gradually expanded communication with markets. However, he always maintained enough ambiguity that investors had to place bets based on the most obscure clues—such as the size of Greenspan’s briefcase when attending policy meetings.
“There are many market participants eager to interpret the Fed’s thinking through their own lenses. When the Fed isn’t trying to clarify its views—not with certainty, but with a degree of clarity—this kind of speculation runs rampant,” Crandall said.
Former Fed Vice Chair Don Kohn believes it is perfectly acceptable for a new chair to take time to clarify his own thinking, but he expects Waller will eventually open up.
“At some point, he will need to provide a more detailed economic outlook, explaining his views and how they align with the Committee,” Kohn said. “I don’t think this situation can go on indefinitely.”
Editor/Deng