Rate hikes are on the Fed's agenda

The Fed kept the policy rate unchanged at 3½-3¾% and is now considering raising rates. The median FOMC forecast is for one rate hike this year (previously one cut), with about half the committee favouring no change in rates and the other half forecasting at least one rate increase this year. Fed Chair Warsh made his mark by issuing a much shorter press release that dropped the policy bias and by not answering most questions during the media conference. He clearly envisages a return to a more reactive and less transparent Fed, something last seen under Greenspan.  He also announced a raft of taskforces to take up the FOMC’s time. Policy rules now point to a peak in the policy rate of about 4½% (previously around 4%).   

Key developments were:

• A much shorter press release with no forward guidance.
  The press release was reduced in length by two-thirds, and forward guidance in the form of a policy bias – which was previously an easing bias – was purposefully dropped from the statement
  
  
• Rates on hold with the FOMC now narrowly expecting a rate hike this year given higher inflation.
  In a unanimous vote, the funds rate was left unchanged in a range of 3½-3¾%, which was the only policy option tabled at the meeting. Warsh did not submit forecasts for the dot plots and very clearly plans to stop publishing them by the end of the year. The median forecast for the funds rate from his colleagues is for one rate hike by the end of 2026, one rate cut by the end of 2027, and one rate cut by the end of 2028 (previously one rate cut in 2026, one rate cut in 2027, and no change in 2028). The median masks a large dispersion of views for 2026, where one person expects a rate cut, eight expect no change in rates, three expect one rate hike, five expect two hikes, and one expects three hikes (as an aside, note that ultra-dovish ex-White House advisor Miran has left the committee). The committee expects higher core inflation in 2026 of 3.3% (previously 2.7%), slowing to 2.5% in 2027 and 2.1% in 2028, where nearly every committee member believes the risks to core inflation are to the upside. The outlook for unemployment was little changed at 4.3% for the next couple of years, practically the same as the estimated NAIRU of 4.2%.  

• Policy rules now point to a 4½% funds rate (previously 4%).
  For a long time, policy rules have pointed to a higher funds rate of about 4%, indicating that the Fed should not have cut rates by as much last year. Policy rules now point to a peak in the funds rate of about 4½%, based on the forecast of higher inflation and a relatively balanced labour market. This is almost the same as the top of the 2.9-4.4% range of FOMC members' forecasts for the funds rate over the next year and a half.

• Fed Chair Warsh is clearly aiming for a more reactive and less transparent Fed.
  Warsh confidently gave lots of non-answers in his press conference, repeatedly stating that the Fed would achieve price stability (for example, when asked “one might wonder why you didn't raise rates today considering what you're saying [in the press release] about the risks to US inflation”, he replied, “My answer to your first question is going to be curt, I've got nothing more to say than the statement itself”). He envisages a reactive Fed with more reliance on real-time private-sector data. He wants to curtail Fed communication and expects the market to provide an “unfiltered reaction” to incoming data for the Fed to analyse. Warsh implied that he had not spoken with President Trump on interest rates (“On the president, I don't have anything”).

• Lots of task forces to take up the FOMC’s time.
  Warsh announced five taskforces, where the standard bureaucratic approach is to design a taskforce to deliver pre-determined findings. The taskforces cover:
  (1) Fed communications.
  Warsh wants to greatly limit Fed communications, starting with dropping the dot plots by the end of this year (“By the time we get to the end of this year, I wouldn't be surprised if there was a new communications framework, there were some changes to the [dot plots]”);
  (2) The Fed's balance sheet.
  Warsh wants to shrink the balance sheet, something that presumably will take time;
  (3) The Fed’s use and reliance on existing data sources.
  The Fed Chair believes that real-time private-sector data are superior to the official statistics. While it is true that the response rates to the surveys underpinning the official economic statistics have fallen sharply over the past ten years, it is not clear that high-frequency private-sector statistics are a good substitute as they often require substantial manipulation to align them with official indicators. The use of real-time data exploded during COVID and while such stats are good at picking very big swings in the economy, they have extremely short histories, are highly volatile, require substantial cleaning, and are often condensed using simple aggregate indicators because the volume of information is hard to interpret. Put another way, greatly increasing the number of high-frequency observations on the economy does not necessarily provide a better signal of its state, and more data points can delay decisions;
  (4) Productivity.
  Warsh is a big believer that AI will boost productivity and reduce price pressures, but he ignored a question on whether AI would boost inflation in the short term; and
  (5) The Fed's inflation frameworks.
  This taskforce spans measuring and modelling inflation and policy instruments. The Fed continually refines its modelling approaches and has published alternative measures of inflation for years.  Warsh favours trimmed mean measures of inflation over the commonly used core PCE deflator that simply excludes food and energy prices. Trimmed mean inflation is currently below the core PCE inflation rate, but the monthly trimmed inflation rate has recently picked up.