WARSH, THE FED AND MARKET SIGNALS / THE WALL STREET EDITORIAL

Warsh, the Fed and Market Signals

He has a hard 2% inflation target, and pays attention to what markets are telling the central bank.

By The Editorial Board

A trader works, as a screen broadcasts a press conference by U.S. Federal Reserve Chair Kevin Warsh on Wednesday Brendan McDermid/Reuters

Kevin Warsh is settling into his chairmanship of the Federal Reserve, and his message after this week’s Federal Open Market Committee meeting is that he sees early signs his method is working. 

He has an interesting point about market signals.

The FOMC kept its Fed funds rate target range in place again, at 3.5-3.75%, although with three dissenting votes in favor of an increase. 

It’s hard to second-guess that decision given a confusing environment that includes recent signs of slowing inflation but also the prospect of more energy-price shocks, the artificial-intelligence revolution and shifting tariff policies. 

The dissenting votes signal healthy debate about these matters.

His post-meeting press conference also was enlightening, even without “forward guidance” about Fed intentions. 

One important message is that the Fed’s inflation target is 2%, and not a little over 2% or any percentage rate that starts with a 2. 

It’s an important marker for Mr. Warsh to lay down, since the Fed periodically faces the temptation of outside economists arguing it should fudge the target.

Mr. Warsh also suggested his no-forward-guidance policy is working. 

Since his first meeting as Chairman in June, investors have had to relearn how to price risk themselves without being steered by the Fed. 

One result has been that bond yields are rising across the duration curve. Another is that the dollar has appreciated modestly.

Mr. Warsh flagged that these and other developments are indicators the FOMC was able to feed into its discussion of economic conditions this week. 

Yes, even the dollar, which he mentioned twice in his press conference—contrary to his predecessor’s habit of passing the buck (pun intended) to Treasury concerning exchange rates. 

The point, as he put it, is that “market participants are learning to play the ball and not the referee.”

How to interpret those signals is another question. 

Mr. Warsh says he sees signs investors are confident the Fed will achieve its price-stability mandate. 

Rising yields may in part signal enthusiasm about more robust future economic growth, though they could express unease about rising potential inflation. 

If the latter, investors have modestly tightened financial conditions on their own—while delivering a more reliable warning than surveys about inflation expectations.

The Warsh Fed is a policy work in progress. 

A notable early feature is some humility about the central bank’s relationship with markets, and that’s a refreshing change.