FOMC preview: New chair, big questions

Bloomberg News

The Federal Open Market Committee enters a new phase this week as Kevin Warsh takes over as chair. Analysts expect the fed funds rate to remain in a range between 3.5% and 3.75%, but speculation percolates about what the changes in leadership will bring, especially in terms of communication.

James Ragan, co-chief investment officer and director of investment management & research at D.A. Davidson, expects the Fed to hold rates, but will "likely" remove the easing bias.

"In April, three of the twelve voters wanted to remove the easing bias in the Fed policy," Ragan said. "Both inflation and employment trends are higher since the April meeting, strengthening the easing bias dissenters' position, making it very likely in our view that the easing bias will be removed."

The FOMC will release a new Summary of Economic Projections following the meeting. Ragan said it's likely the Fed's projection of one cut for the year will change to no cuts this year and even could suggest one rate hike, as the fed funds futures suggests. He does not expect the dot plot will predict a hike.

About Warsh, Ragan said, he "is eminently qualified as Fed chair, with successful previous time at the Fed, along with strong academic and business credentials." Further, his comments to the Senate back "Fed independence and [he] said the Fed must earn its credibility. We don't believe that he will succumb to political pressure or make decisions without rigorous supporting data."

Warsh's view of inflation was "more hawkish" than expected, Ragan said, and it "creates more uncertainty in the current environment."

Although Jerome Powell as chair expanded communications, "Warsh has also expressed an interest in changing the Fed's communication strategy," Ragan said. This could mean fewer press conferences and an overhaul of the SEP, he added. Warsh feels the press conferences add volatility and the SEP is viewed as a forecast, Ragan noted.

"We prefer more data, not less, and argue against those changes," he said. "We are open to hearing arguments in favor of some changes but also assume that communication changes could be received negatively by markets initially."

FHN Financial Chief Economist Chris Low said Warsh's first meeting since March 2011 "is shaping up to be the most interesting FOMC meeting in years," although it looks like there will be no dissents to holding rates.

"Markets will focus on the changes to the statement and the SEP, but the biggest takeaways from the June meeting will come from Warsh's press conference," he said. "Traders will be eager to see his communication style and how willing he is to answer questions about future policy decisions. We think Warsh will use the first press conference to announce the first steps in his 'regime change' that may well already be underway, and how he will deal with rising inflation."

Low also expects the deletion of the panel's easing bias. "This is not to say the Fed will tee up rate hikes in [this] week's meeting. They are finishing the shift that began in January, from 'we are waiting until we can cut rates again' to 'we will adjust policy when needed, in the direction needed.'"

In the post-meeting statement, Low expects changes to the description of the labor market, which saw "stronger job gains in the past few months," while the inflation language will be unchanged.

"We don't expect the Warsh press conferences to mirror Powell's," Low said. "We can only guess at Warsh's demeanor. It is impossible to know exactly how he will handle the press until he walks out on Wednesday."

But, he noted, Warsh is not a fan of "forward guidance and will likely be dismissive of questions about policy decisions later this year."

As for the SEP, Low sees higher inflation forecasts, lower unemployment rate predictions, and fed funds medians higher for this year and next.

"Markets are used to Powell's measured, soothing demeanor," Low said. "Warsh's public comments suggest he may lean towards tough love and a 'we'll-see' attitude toward future policy choices. Beyond the rate call, expect surprises about balance-sheet management, communication, and any number of other, smaller issues in the press conference. The new regime starts now, and Warsh is determined to make changes."

Scott Colbert, Commerce Bank chief economist and director of fixed income management, noted that lowering the balance sheet would initially likely raise bond rates. "I think what you'll see is a steeper interest rate curve if you can convince the Fed to basically continue to lower its balance sheet."

The yield curve has finally become positively sloped, he said, because the bond market at the beginning of the year expected the Fed to cut rates twice in 2026.

"The bond market is expecting the Fed to actually raise rates once by the end of the year," Colbert said. "I think the Fed is likely to be on hold, but interest rates in general have risen, mostly because we're still running this massive deficit."

The BNP Markets 360 team expects the FOMC to "adopt a symmetric policy bias," whereby "either a hike or a cut would be an equally plausible next step. This move, which was hotly debated at the April meeting, seems to have become a consensus for policymakers following subsequent robust labor data."

Warsh's answers in his press conference will likely be "succinct," they said, "and proffer little in the way of forward guidance."

They expect three sequential rate hikes starting in December. The post-meeting statement will be pared back to the way it was before the global financial crisis, describing any policy action, offering a summary of current conditions for growth and inflation, and expressing a qualitative bias for actions at upcoming meetings. "However, this might take time," they said.

BNP expects Warsh to continue the press conferences after every meeting, but sees a more concise opening statement and questions answered "with relative terseness."

"As a result, the conference might move much more quickly, take much less time, and seem more controlled and less informative than was the case under Powell," they said. "Warsh will probably say little about where policy is going, indicating that the FOMC voted only on the current action and that what happens at future meetings will depend on how the economic outlook evolves."

As for the SEP, they said, "this is more likely than not its last hurrah.

"Warsh has been pointedly critical of the SEP over the years, believing that it entrenches policymakers in their views, and we think his colleagues will see this as a battle not worth fighting," the BNP team said.

"Having been sworn in only 3½ weeks before the meeting, it will be interesting to see how the new Fed head, with his reported predilection for lower policy rates, embraces the FOMC's expected decision to drop the easing bias and signal that the next action could be a rate hike just as easily as a cut," said BMO Deputy Chief Economist Michael Gregory.

For the dot plot, BMO sees a pause this year, with one cut each of the next two years. "And we would not be surprised if at least one participant pencils in a hike for this year."

Still, this will be the beginning "of Warsh's efforts to effect change at the Fed," Gregory said.

"And it is going to be much more of an evolutionary process than a revolutionary one," he said.

"Kevin Warsh's arrival as chair adds uncertainty mainly around communication," said Paolo Zanghieri, senior economist at Generali Investments. "Sweeping policy changes are unlikely without a committee majority, but the message could change quickly: a simpler framework, less guidance, more data dependence and shorter statements."