Almost a week on, and the collective sell side mental breakdown over Fed Chairman Warsh’s press conference last week continues. It appears that, after a decade or two of having every policy move spoon-fed to them, many are struggling with the fact that they might actually have to start doing their jobs properly again.
Yes, you will need to actually take a view on the economy. Yes, you will need to formulate an opinion on how the outlook may evolve. Yes, you will need to come up with a stance on the Fed’s reaction function. And, yes, you will have to map all of that onto how the policy path is likely to pan out.
Sounds like hard work? Well, you did sign up for it.
Frankly, the fact that so many are either unwilling, or unable, to grasp the fact that the Fed is no longer holding their hand is in equal parts hilarious, and farcical to watch. The wailing from the sidelines is also utterly pointless, considering that Chairman Warsh is hardly going to read a handful of research notes then suddenly change his ‘modus operandi’, having planned for and wanted the job he now has for at least 20-odd years.
The era of forward guidance is over, the age of explicit hints as to future rate moves is behind us, and the days where FOMC decisions would essentially be pre-announced are long gone. For market participants, ultimately, it’s now a case of ‘adapt or die’.
Either, continue to moan and groan about how the Fed are now doing things, and constantly harken back to the olden days. Or, get with the programme, tear up your preconceived ideas about how the institution ‘should’ operate, and instead invest time into reading the tea leaves as to how the Warsh Fed will work.
Because, for all the grumbling, we actually know quite a lot on that front already. For instance, dissent is clearly now welcomed, rather than discouraged as was the case in the consensus-building days of Powell and Yellen. Furthermore, Warsh’s focuses as Fed Chairman are explicit - moving away from data-point dependency, and instead focusing on the underlying trends in that data, throughout the entire forecast horizon. His goals are clear too, engineering more broad-based economic growth, and more limited inflation. Spend less time looking at headline CPI or PCE, and more time looking at the proportion of the basket where prices are rising at an above-target pace.
Most importantly, Warsh’s near-term tactic is to get the markets to do the work for him. Flagging the rise in Treasury yields between the June and July meetings explicitly at the press conference was a deliberate signal that the FOMC are fully aware of the tightening in financial conditions seen over the last six weeks. Said tightening is not a ‘bug’, but a ‘feature’. In fact, the whole plan for now is for Warsh to talk as tough as possible, thus avoiding the need to take the tough action of a rate hike, providing that the data behaves itself; which, right now, it is likely to do, as disinflation resumes through H2.
From a market perspective, all this will lead to higher UST and STIRs vol, as participants are forced to shift from flying on autopilot, to ‘flying blind’ so far as the policy path is concerned. Every FOMC confab will now be live, which will also increase hedging activity into those events. Further curve steepness is also likely, particularly with ~50bp of tights being discounted by swaps over the next 12 months, which seems unlikely to be delivered.
In equity land, it’s close to the best of both worlds. Already, the market is displaying robust earnings growth, in line with resilience in the underlying economy. Now, you’ve the additional tailwind of a likely dovish repricing in Fed policy expectations, coupled with a desire ‘from the top’ to broaden out that solid pace of expansion. The path of least resistance continues to lead higher.
All told, it’s time for folk to get with the programme. Whether one likes it or not, Warsh is running the show now, and will be for at least the next four years. Once more, plenty of participants appear to be letting their politics impact their PnL - you’d have hoped people would know better than that by now, given recent experience!