JAKARTA - The Federal Reserve (The Fed) is entering a new phase under the leadership of Kevin Warsh. In his first press conference as Chairman of the US central bank, Warsh hinted at major changes by reducing the policy guidance (forward guidance) which has been one of the main references for market participants in reading the direction of interest rates.
Over the past two decades, the Fed has been known to be increasingly transparent in communicating economic projections and monetary policy directions. However, Warsh believes that the market has become too dependent on the signals given by the central bank, reducing the market's price function as an independent economic indicator.
As a first step, the Fed cut the length of the policy statement to 132 words from the previous 341 words in April. Warsh also emphasized that the latest statement deliberately did not contain any clues regarding the direction of interest rate policy at the next meeting.
The change in approach immediately triggered market reactions. The yield on 10-year US government bonds rose to 4.49 percent from the previous 4.43 percent. Meanwhile, the yield on two-year bonds increased to 4.16 percent from 4.05 percent. In the stock market, the S&P 500 index corrected 1.2 percent after the announcement of the policy and Warsh's press conference.
"In general, forward-looking policy guidance has served to suppress volatility and stabilize market expectations," said Bespoke Investment Group global macro strategist George Pearkes, as quoted by CNBC, Sunday, June 21.
According to Pearkes, the impact on consumers is likely not too large in the short term. However, mortgage interest rates could potentially be higher than if the Fed had continued to provide clear guidance to the market.
Warsh's approach reminds many observers of the era of Alan Greenspan who led The Fed from 1987 to 2005. At that time, the US central bank was known to give little guidance so that investors had to interpret the direction of policy themselves based on available economic data.
In addition to changing the communication pattern, Warsh also announced the formation of five task forces that will evaluate various operational aspects of The Fed. The study includes monetary policy communication, central bank balance sheet management, methods of collecting economic data, the impact of artificial intelligence on productivity and the labor market, and the refinement of the inflation analysis framework.
"This is a big change in the way the Fed has acted since the global financial crisis (2008-2009)," said Deutsche Bank's Chief U.S. Economist, Matthew Luzzetti.
According to Luzzetti, since the global financial crisis, the Fed has consistently expanded transparency and communication to the market to maintain financial stability. However, this direction is now beginning to shift under Warsh's leadership.
Warsh argues that the price of financial assets should again become one of the main sources of information for central banks. Therefore, investors are encouraged to form their own expectations based on economic data developments, not just relying on official signals from the Fed.
"Financial market prices are probably the most important source of information to guide central bankers," Warsh said.
Despite receiving support from some economists, this approach has also garnered criticism. Professor of Economics at the University of Miami and former economist at the Federal Reserve Bank of St Louis, David Andolfatto, assessed that the elimination of forward guidance must be accompanied by a clear strategy in the face of potential economic turmoil.
"I agree with him to remove the guidance going forward, but you have to replace it with an emergency plan. It's not enough to just say, trust us, we'll keep inflation on target," Andolfatto said.
A number of analysts assess that Warsh's greatest leadership test will come when the market faces a crisis or significant economic pressure. In such situations, central bank communication has proven to be an important instrument for calming panic and maintaining the stability of the financial system.
"Whether that will last long and he will behave like this for five years is a very different question. We have to wait for the development of events to get the answer," said Pearkes.
For the global market, this change in the Fed's communication style is a signal that the era of central banks actively guiding investor expectations may be coming to an end. Going forward, market volatility could potentially increase as investors have to rely more on economic data than direct clues from the US monetary authorities.
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