The new chairman of the Federal Reserve, Kevin Warsh, is brewing the most profound institutional changes in decades.

Written by: Zhao Ying

Source: Wall Street Insight

The new chairman of the Federal Reserve, Kevin Warsh, is preparing to implement the most profound institutional restructuring of this globally influential central bank in decades, with the core focus targeting its communication with the market.

According to a recent report by the Financial Times, several former senior officials of the Federal Reserve expect that Warsh will initiate reforms as early as the upcoming Federal Open Market Committee (FOMC) meeting in mid-month.

Specific measures include: refusing to submit individual interest rate forecasts in the quarterly "dot plot," and removing language that implies a "dovish" or "hawkish" bias regarding future actions from the policy statement. This series of changes will fundamentally alter the communication logic between the Federal Reserve and Wall Street.

The above reforms are expected to have a direct impact on the market. The dot plot has traditionally been an important anchoring tool for the bond, currency, and stock markets, with its fluctuations often causing significant asset price volatility. Once Warsh implements these changes, investors will face greater uncertainty regarding the interest rate path, and the market's interpretation of Federal Reserve policy signals may be forced to restructure.

Warsh clearly opposes forward guidance, determined to reform

Warsh was sworn in by President Trump in May this year, succeeding Powell as chairman of the Federal Reserve. He has publicly expressed his opposition to forward guidance.

During the Senate confirmation hearing in May, Warsh stated clearly, "Unlike many of my colleagues in the past and present, I do not believe in forward guidance. I do not think I should forecast what future decisions might be." Subsequently, both Trump and Treasury Secretary Mnuchin publicly stated that Warsh intends to reduce forward guidance.

Warsh also criticized the dot plot for causing officials to cling to their original judgments even after economic realities have changed, leading to policy errors. Former senior Federal Reserve officials, and current chief economist at BNY Investments, Vincent Reinhart, stated, "Warsh recognizes that the Federal Reserve is not a particularly good forecaster, and doing things it is not good at does not enhance its credibility." He added, "If you think this work has no value, you probably wouldn't want to be involved in it either."

A consensus has formed within the committee to remove biased language

There has been a clear consensus within the FOMC regarding the removal of biased language from the policy statement.

The current "dovish bias" language of the Federal Reserve has previously faced criticism from multiple policymakers. During the FOMC vote in April, three regional Federal Reserve presidents—Beth Hammack, Lorie Logan, and Neel Kashkari—objected on the grounds that the potential for a new wave of inflationary pressure from the Iran conflict warranted re-evaluation. Subsequently, Federal Reserve governors Christopher Waller and Lisa Cook also expressed their views, stating that the dovish bias language should not continue to be retained in the statement.

Former Federal Reserve Vice Chairman and current global economic advisor at Pacific Investment Management Company (Pimco), Richard Clarida, believes the timing is quite favorable for Warsh: "All the conditions align, and Warsh would see this as a positive aspect, with the committee also viewing it positively—that is to directly remove all guiding language from the June statement."

Debate over the fate of the dot plot: Tension between market anchoring function and reform logic

The dot plot was introduced by former Federal Reserve Chairman Bernanke in 2012, requiring 19 FOMC members to submit interest rate forecasts quarterly, covering levels for the coming year, two years, three years, and long-term neutral rates. Although initially positioned as "soft guidance," its impact in the market has far exceeded its original design.

Blake Gwinn, head of U.S. interest rate strategy at RBC Capital Markets, stated, "Whether you like or hate the dot plot, it provides a very important anchoring mechanism." Guy LeBas, head of fixed income at Janney Montgomery, also believes that the dot plot helps "suppress interest rate volatility."

However, some FOMC members have long been dissatisfied with the dot plot, believing that the market's over-interpretation has deviated from its original purpose. Former Kansas City Fed President Esther George pointed out that the dot plot "was originally viewed as a form of soft guidance, but the market's interpretation has far exceeded its intended use and is now seen as guidance for the interest rate path."

Opposition to abolishing the dot plot also exists. Former St. Louis Fed President James Bullard argued that abandoning the dot plot would go against the "international practice" of central banks providing sufficient policy information to the market, also noting that the terms "dovish" or "hawkish" were used during Alan Greenspan's tenure (1987 to 2006)—and Warsh himself has repeatedly expressed a desire to emulate Greenspan's style.

Although the direction of reform is already quite clear, the institutional inertia of the Federal Reserve may cause the reform process to slow down. Reinhart stated, "The entire communication system is a massive building, and he must carve it out bit by bit. The transition at the Federal Reserve will not be quick." Some current and former officials prefer to establish a new communication framework before abandoning the old framework, rather than indiscriminately tearing it down.