Fed change is afoot, in more ways than one

Change is afoot

Before we dive into the forthcoming change in leadership at the U.S. Federal Reserve, there were some notable – and possibly even surprising – developments as it pertains to the monetary policy outlook.

Given that AI is all the rage, what does it have to say about the Fed’s current stance? The first chart shows a natural language model from Bloomberg that scores the Fed chair’s opening statement in terms of what it perceives to be hawkish sentences and dovish sentences, as well as an overall score – and covers the span of Jerome Powell’s tenure as chair from March 2018.

Language model of Fed sentiment leans most hawkish since 2023

Clearly, the model flagged a significant shift in tone at this week’s meeting from mildly dovish in March to the most hawkish since 2023. Perhaps that’s unsurprising given the ongoing risks posed to inflation from the emergence, and duration, of higher oil and gas prices.

But it’s not just an oil and gas price story. Back in January, some policymakers were already seeing the need to communicate to markets that there are “two-sided risks” to the outlook for rates – or that a rate cut could be just as likely as a rate hike. That cohort of “some” in January grew to “several” at the March meeting, having culminated in three official dissents at this week’s meeting. To be clear, the dissenters sided with the decision to hold rates steady; they simply wanted to explicitly note those two-sided risks.

And the change they wanted to make to the statement was possibly as innocuous as deleting one word: “additional.” As the official policy statement currently reads: “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook and the balance of risks.” (Emphasis ours.)

After a series of rate cuts, we think that verbiage implies a further easing bias. The removal or modification of “additional” would reflect a more neutral outlook, or one where the next step could either be a cut or a hike dependent on how the economy evolves.

When asked why the change in language wasn’t made at this meeting, Powell noted the significance of such a shift as it relates to the forward guidance provided to markets and that most at the Fed still wanted to wait and assess further economic data before making the pivot.

Now the stage is set for a new Fed chair in Kevin Warsh (full Senate confirmation is expected in early May) and the next phase of monetary policy setting. Will that amendment be made at the next meeting in June? Will there be interest rate forecasts? Will there even be a press conference? Will there be anything at all?

Kevin Warsh to take the helm

Warsh has often spoken of his desire for “regime change” at the Fed, specifically with respect to how it makes policy decisions, what those decisions are based upon and how those decisions are communicated to the public.

He has explicitly stated that he is not much of a fan of forward guidance, that the Fed communicates too much and that a press conference after every meeting might not be necessary. He has even entertained the idea that the Fed – at eight meetings per year – meets too often.

While we don’t expect any major changes by his first meeting at the helm in June, and though these are things that may not have a direct market impact, we think it will be a slow-moving process that could be significant at the margin.

Part of his disdain for forward guidance, and forecasts such as those in the Fed’s interest rate “dot plot,” seemingly stems from the idea that it relies too greatly on economic forecasts, that it ties the Fed’s hands and that it confuses markets. It was Powell who increased the frequency of press conferences to every meeting, compared to only the quarterly meetings that featured updates to the Fed’s Summary of Economic Projections. Then there’s also the matter of Warsh’s desire to see a smaller Fed balance sheet.

A lower level of transparency and communication could buy the Fed flexibility, but like anything it comes with a cost – potentially in the form of steeper yield curves and higher term premiums for longer-dated bonds, in our view. While the Fed controls short-term interest rates, it has less influence on longer-term rates, such as the 10-year Treasury yield, which tend to more directly affect consumer and business lending rates. Forward guidance, the balance sheet at times, and jawboning are all tools at the Fed’s disposal to anchor yields modestly lower when desired. A rejection of those tools could cause market participants to demand greater yield compensation to buy longer-dated bonds.

Ultimately, while Warsh will likely come in with a bias toward further rate reductions, we see risks that some of his proposals could actually be a disservice of that objective.

Should rate hike risks be taken more seriously?

While Warsh faces what appears to be an increasingly divided voting committee, it’s not just policymakers who are flagging the possibility that the Fed could pivot to rate hikes, so too are consumers.

Also released this week, the Conference Board’s Consumer Confidence Survey found that 63 percent of those surveyed expected higher interest rates ahead, up from barely 50 percent last fall. The average reading of the survey over the past year has now risen to 55 percent, continuing a higher trend that had already begun back in Jan. 2024.

Consumers increasingly think higher interest rates could be in the pipeline

Consumers actually have a pretty solid track record of getting the Fed call right. And with more consumers expecting higher rates, that’s now at odds with a Fed that at a minimum is likely to keep rates unchanged this year, if still trying to maintain a policy easing bias.

Waning influence

Above all else, perhaps the key takeaway for investors is this: the Fed chair’s influence has been waning for decades, and we think that continues with Warsh’s likely confirmation.

The days when Fed chairs, such as Paul Volcker, Alan Greenspan and Ben Bernanke, arguably held outsized stature and influence over the institution they served seems to have faded under Powell. Perhaps that will be his legacy – not just the defence of the independence of the Fed, but the elevation of the broader voting committee and consensus-based decision-making that is bigger than any individual.