ROI-A 50 bps rate hike? Warsh's Fed has a comms problem: McGeever

Federal ​Reserve Chair Kevin Warsh's disdain for "forward guidance" is clear. Unfortunately, what is filling that communication void is anything but. Since replacing ​Jerome Powell as Fed chair in May, Warsh has been on a mission to ‌overhaul ​nearly every aspect of how the central bank functions, from reducing the number of policy meetings each year to completely restructuring its decision-making framework. Muddled messaging has become a feature of the new-look Fed, not a bug.

Warsh has repeatedly steered markets away from putting too much weight on single data points and has argued that the Fed should not tie itself to forecasts. Yet ‌we saw precisely the opposite in London on Tuesday from Fed Governor Christopher Waller. He said a 50-basis-point rate hike next month should be on the table if the monthly rise in core Consumer Price Index (CPI) for October due yesterday was 0.3% or more. A few hours later, it was confirmed at 0.3%.

Waller’s hawkish curveball triggered a sharp spike in US bond yields and left investors confused about what policymakers' “reaction function” actually is. 'ALL OVER THE PLACE'

Waller is considered one of the most influential members of the central ‌bank’s 19-strong Federal Open Market Committee. And he has been on quite a policy journey recently, underscoring the larger problems with Fed messaging. He voted against the FOMC's decisions to keep rates on hold in July last year and again in ‌January, both times dissenting in favor of lowering rates by 25 basis points. As recently as March 20, he said, "If the labor market continues to be weak, I would start advocating again for cutting the policy rate later this year."

To go from that to putting a half-percentage-point hike on the table in barely seven months is quite a turnaround. For context, excluding the 2022-23 tightening campaign to combat the historic burst of inflation following the pandemic and Russia's invasion of Ukraine, the Fed has raised its policy rate by 50 bps just once in the last 30 years. And that was in May 2000, a move ⁠that helped burst ​the dotcom bubble. To be sure, the October CPI report showed ⁠inflation is stickier than officials have bargained for. Months of elevated energy prices seem to be spreading through the economy. Still, the timing of Waller's hawkish lurch is odd. Since the Fed left rates unchanged on October 28, oil prices are down nearly 20%, one-year inflation swaps have slumped back below 2%, ⁠and the AI boom driving the economy and Wall Street has sputtered — the Nasdaq is down 6%, and semiconductor stocks had their second-biggest fall on record last Thursday.

"(It's) hard to understand what his framework is at this point," says Brent Donnelly at Spectra Markets. "The Fed ... is all over the ​place right now as nobody knows what to do with monetary policy in a supply shock." FAMILY FIGHT OR MIXED MESSAGING?

There is another way to look at this, of course. Waller's inflation-specific curveballs may just be one manifestation of ⁠the robust debate taking place around the FOMC table that Warsh warmly refers to as a good old "family fight." A wide range of views among policymakers is healthy and desirable.

But if that leads to muddled or contradictory messaging, it can become problematic. And this is what markets are getting. Recent signals from other Fed officials, ⁠even ​from hawks like Cleveland Fed President Beth Hammack, had indicated a preference for gradual tightening — not a jumbo hike at the meeting immediately following a pause. Indeed, at the end of last week, markets were not even fully pricing in 50 bps of rate hikes over the remainder of the cycle. They’re now expecting 75 bps.

What if October's core CPI had risen by only 0.246% instead of 0.296% and thus been rounded down below Waller’s threshold? Would the 2-year Treasury yield have leaped 20 basis ⁠points on Tuesday, its biggest rise since April last year? Would rates markets be pricing in three more quarter-point hikes instead of two? Unlikely. Putting so much emphasis on specific levels of a specific data point leaves the market dancing on a ⁠pinhead. It also goes against Warsh's ethos that tackling inflation "is not ⁠about some isolated data point" and that "trends matter most."

If that were the case, a 25 bps rate hike last month would have made more sense than a 50 bps one in December. (The opinions expressed here are those of the author, a columnist for Reuters)

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(By Jamie McGeever; Editing by Marguerita Choy)