Ahead Today
G3: Fed's Bowman speaks
Asia: India CPI, India trade
Market Highlights
New Fed Chair Kevin Warsh assembled the key external advisors to lead his five task forces to re-examine the key areas of the Federal Reserve’s conduct of monetary policy. The key names on the list include luminaries such as Mervyn King, former Governor of the Bank of England, Raghuram Rajan, professor of Finance at Chicago Booth and former Reserve Bank of India Governor, and Marc Andreessen, co-founder of VC firm Andreessen Horowitz, among others too many to name.
These external advisors generally align with the views of Kevin Warsh, especially for the case of Fed communications and the impact of AI on productivity and growth. For instance, Mervyn King as Governor of BOE has resisted publishing rate paths, argued that central banks have relied too much on the role of expectations in bringing down inflation, and has been a vocal critic of central bank forward guidance given possible complacency in markets while potentially tying the hands of policymakers in an era of greater uncertainty. Meanwhile, Marc Andreessen has consistently argued that AI is massively deflationary and transformative, as a leading investment practitioner in the field, and Chad Jones has been a leading theorist and proponent of the positive economic impact of AI while also carefully modelling the possible constraints and weak links preventing AI diffusion through the economy.
The one key area of disagreement and tension seems to be on balance sheet policy. While Raghuram Rajan, former RBI Governor and Chicago Booth Professor of Finance has argued about the negative spillovers of Quantitative Easing especially to Emerging Markets, he has also mentioned that shrinking the balance sheet is operationally hazardous. Karen Dynan from Harvard probably comes closest to disagreement with Kevin Warsh on the need for a smaller balance sheet, having supported Quantitative Easing and ample reserves but this was argued in the context of an economy at the lower bound and demand still weak.
Overall, we think that these external advisors bring strong credibility to Kevin Warsh’s push to reform the Fed. When we combine this with Warsh’s ability to communicate clearly what he wants to tell markets (and with that also what he doesn’t want to say), his political astuteness to navigate both the Fed and the broader system in Washington, coupled with his strong network including with the private sector, we think it looks more likely that he will be able to effect big changes in how Fed conducts monetary policy over time.
Our bias is to think that the reduced focus on Fed forward guidance over time could lead to somewhat more volatility in US interest rates, but over here it’s also important for the Fed to communicate its reaction function more clearly. There is nonetheless an important point that forward guidance had probably made the Fed slower to react and tied its hands during the Covid pandemic when the economy was undergoing structural changes, and so a rethink on this front is perhaps not at all a bad thing.
Meanwhile, while the market’s focus may be on the immediate hawkishness of the Fed with strong AI demand for chips and GPUs, the outcome of the Productivity and Jobs taskforce could provide Kevin Warsh some justification to cut the Fed Fund rates over time even if it may only come later in 2027.
Overall our global team thinks that markets are probably too hawkish right now on the path of US rates and as such see some space both for US yields and the Dollar to come off over time.
