Warsh's Opaque Monetary Policy Faces Market Volatility Test

Federal Reserve Chairman Kevin Warsh's decision to be less transparent about monetary policy is set to face a test on Wednesday, as markets are on edge waiting for the outcome of the FOMC meeting. The unusual 35%-65% split in Fed funds futures markets has created uncertainty, with the majority leaning towards holding interest rates steady at 3.63%, but a significant minority betting on a hike.

John Canavan, lead analyst at Oxford Economics, believes that the market volatility around decision time and during the press conference should be minimal, given the high probability of the Fed holding rates steady. However, it remains unclear where else the minority bets might reside, particularly in the larger treasury market.

The 2-year yield has remained elevated despite soft inflation and employment reports, and its failure to decline with the fall in oil prices suggests that there may be considerable bets on the outcome of this meeting in the treasury market. This could lead to increased volatility if the decision does not align with these expectations.

Equity markets have also been sensitive to the possibility of a rate hike, but some hedges against it are still in place. A rate hold by the Fed that comes with multiple dissents or a new line in the statement suggesting a bias to hike could keep these hedges in place, leading to continued uncertainty.

Warsh's approach to monetary policy has been met with skepticism by some, including Fed Governor Chris Waller, who stated, 'In all my years as an economist, I've never seen a single theory that says you make people's lives better or markets work better if you don't tell people what you're thinking.'

Warsh believes that the Fed should be setting policy based on market signals, untainted by Fed guidance. However, it remains unclear what specific signals he is watching and what they are indicating.