Why a Less Predictable Fed Could Mean Higher Volatility | Topical Thoughts

What does Kevin Warsh’s first meeting as Federal Reserve Chair signal for investors? In this Topical Thoughts conversation, Chief Market Strategist & Economist Guy Miller and Head of US & UK Market Strategy Thomas Liebi unpack the Fed’s hawkish shift, the renewed focus on price stability and why markets may need to prepare for less forward guidance and more volatility.

The discussion explores the five Fed task forces, including communications, balance sheet policy, inflation framework and the use of more real-time data. It also looks at how AI-driven productivity could shape the longer-term outlook for inflation, interest rates and monetary policy.

If you follow the Federal Reserve, US interest rates, inflation, bond markets or macro investing, this episode breaks down what Kevin Warsh’s early moves could mean for policy credibility and market pricing.

Transcript

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[Music starts][Subtitles are AI generated] Welcome to another edition of our Topical

Guy Miller, Chief Market Strategist & Economist, Zurich Insurance Group: 0:04

Thoughts series, where I'm joined by Tom Liebi who's just written a paper on the changing of the guard at the Federal Reserve. Now, Tom, we're recording this just after the news of the passing of Alan Greenspan. He was the first Fed chair that I remember on a professional basis, and in many ways he marked the changing the guard back then when he came in, and of course he was at the Fed for many years. We've just had Kevin Warsh... Have his first meeting as Fed Chair,[Music stops] much anticipated, giving the build-up to this, with the comments from the US President, of course, appointed by the US president, as was his predecessor, Jay Powell. Firstly, what were you expecting and what was maybe the surprise at that very first meeting? Well look, to the question what we were

Tom Liebi, Head of US & UK Market Strategy, Zurich Insurance Group: 0:51

expecting, probably like many of us, given the whole discussion about Trump nominating Kevin Warsh after a long discussion, probably everybody was expecting a slightly dovish-fed chair, meaning leaning towards rate cuts, also based on some arguments that Kevin Warshe himself made, I mean remember he was quite vocal about emphasizing. The potential productivity gains coming from AI, which means we could have economic growth without necessarily stoking more inflation, which was kind of leaning towards a more of which then. In fact, even more than that, we had, in the buildup to this, almost every contender was trying to out-dove the other one because they all knew the president wanted rates to be coming down. I think Donald Trump was quite clear on that one. So no, clearly, I think that came as a surprise that he did not only not mention rate cuts, he basically also didn't fight back against, for example, the quite hawkish shift by his committee members. Remember, nine dots, nine committee members now actually see rates higher by year-end. Some even see two rate hikes or three rate hike, so he didn't push back. Also, he didn't provide his own forecast. And even the speech itself was quite hawkish, I mean he emphasized the price stability about a dozen times and that's right, I means that is the Fed's main job. And he also acknowledged that the Fed has failed in reaching its inflation targets for five years in a row and based on the latest statements, the latest projections, they probably will fail again this year and maybe even next year. So emphasizing this goal, this return to creating, to reaching price stability. Was in itself quite a hawkish message and that probably was one of the biggest surprises coming from the ladies. I mean, he went out of his way almost to say that the Fed has missed for five consecutive years that part of their mandate. So I'm not sure if that's what the President was expecting to hear. So what was the tone that Warsh was trying to present here? Was he trying to win over the investor base? I mean he'd already had an agreement with the President, you know, I need the credibility, I have to go in tough to begin with. Or am I being too cynical about it all? Look, I don't know whether there has been any pre-arranged agreements how to enter the new role as a Fed chair, but quite clearly the message came across slightly differently, clearly more hawkish as I mentioned than what many expected. But I personally think it's a positive because, and maybe that's also why he did it, I He was expecting him to be... Well, let's say the Trump nominated chair that is now following Powell, which, by the way, was also nominated by Trump. So he probably felt the need to place himself as being independent. He's not simply coming in as a Trump nominee, ready to cut the rates, whatever happens. So clearly for me, that was a statement, look, I'm here, I am independent, I do look at the data, and I'm really... Focusing on the two main mandates, which is maximum employment and price stability, but currently it's mostly about price stability. So for me that was setting a signal to really gain credibility after all the speculation that we have seen and heard and read about pre-war. So for that was probably the main reason why he came across as more hawkish than many expect. I know we've written and we've spoken about the fact when we heard that it was going to be worse, you've got the top job, that we applauded that. We felt that he was a known quantity. We felt he upheld the values of an independent central bank. And we also believed that he was going be very data dependent, everything that you want from a Fed chair. So I guess from what we've seen in that initial outing, all of these boxes were kind of ticked. He the size. The importance of the Fed, he emphasized the importance of data and he emphasized the importance of that kind of independent way of thinking about things. But we also know that in the past, he has been somewhat hawkish in terms of the Feds balance sheet. We know that he's speaking about setting up committees. Now, maybe you could elaborate a little bit on this because all I heard was there's what five committees being sent up on a multitude of different topics. So what is he trying to achieve? Why do they matter and what do you think the outcomes are going to be? Look, I mean, you mentioned these five committees or task forces that have been implemented and I think it's not new if you come in as a, well, as a Fetcher or as any new CIO in a company, you probably want to, well not maybe necessarily shake things up, but you want to review things, you want to fundamentally reconsider maybe some things to do and the best time to do so is when you enter the job. So yes, he did announce or implement five task forces. The balance sheet is certainly one of them. I mean he was quite critical about balance sheet expansion And he probably still is but that doesn't mean we'll see a shrinking balance sheet on day one And that's that's I think that's the other important takeaway He did announce these talk forces, but he also announced that he does not necessarily expect any results before year-end So that also probably created some stability. I'm in some some let's say predictability in the markets that he's not here to fundamentally turn around and change things by day one. On the other hand, another task force was also is dealing with communications. And I think that's the one thing where we already saw the biggest change. I mean, look at the Fed statement. It's much shorter, much more concise, kind of precise, maybe if you want to put that way than the statements before. It's also, he refused, as I mentioned, to provide the prediction by himself. I mean, obviously let the others provide their dots and forecasts. He doesn't want to provide any forward guidance. And quite honestly, I think that also makes sense because this forward guidance, the dot plot, they were created at a time when, it seems like a very long time ago, we had zero rates in some parts, negative rates. So there needed to be some pre-commitment that the Fed didn't want change or touch rates, but. Nowadays, where we are in a more normal business environment, a more normal economic cycle, I think it's first of all doesn't work because data change, the world changes and I think it doesn't add to credibility committing to something that you then have to change or maybe even feel obliged to follow up on despite the change in data. So I think getting rid of that maybe reduces transparency to some degree can increase volatility. But it's not the bad thing. I think it leaves the Fed more nimble, more active, more able to react to incoming data. But I think your point is a very valid one. I think there's a time and a place for forward guidance. When you're in a very challenging environment, you want to build confidence, you want to set the stage, you to give direct travel, and it works. When you are in more normal times, I would say that you want market forces to be working. And it's funny, we mentioned there the passing of Alan Greenspan. But I remember the days when the only guidance you got was how thick is Alan Greenspans briefcase when he went to the Fed? Because. That kind of gave you an indication of how many documents are in there. That means they've got more to speak about. That means there could be a change in policy. But it was up for the financial markets to interpret the data rather than being, as I would put it, spoon fed. So I would take that as a positive, but will that lead to more market volatility? Have markets forgotten how to interpret the data and what the Fed may be thinking. Well, yes, first, the answer I think is yes, it probably will create some more volatility, but that's not in itself a bad thing because having this kind of stable, almost pre-committed major central bank, it's probably also, well, first of all, it did lead to maybe some complacency, as you pointed out. Maybe market participants, investors felt like less of a need to really dig into data. And it also probably put some pressure on the Fed committee, on the fed members to maybe follow up on their guidance, although they might actually didn't fully believe in it anymore because the data has changed. So clearly it is, in my view, it's a step in the right direction. If you talk about efficient markets, about price finding processes, maybe not everybody will like it because yes, it is less transparent. It is leading to more volatility. And in that regard, it probably is a little bit. Of a time trial back to the Greenspan era, which, by the way, is also one central banker that was admired or is being admired by Kevin Morrish. So clearly, we do see the potential of a substantial change in the way the Fed works, the Fed communicates, and maybe even the emphasis of different objectives. I mean, price stability should always have been the main or one of the main objectives by the Fed, but... Looking back, and as we discussed briefly, having failed for five and maybe six years in a row just tells me that maybe the emphasis was not strong enough. So going back to that. But here's the question, it's fine talking about and setting all these committees and we can come back to what the outcomes of these committees are going to be, but he made the point that they've missed for five consecutive years and you implied that they're going to miss again. So why are they not moving now? I mean, they've moved from a dovish leaning Fed, or I guess in terms of narrative, to something more hawkish. But you could surely challenge them and say, well, if you look at the data, if look at where inflation is, way above target and rising, if really believe in price stability, isn't it time that you stepped in on day and you move rates. I mean, that's a very good point, but I think that's probably where I think at least where markets got a little bit ahead of themselves. I mean emphasizing price ability in the long term, that is exactly what the Fed should do or what any Fed share should do, but we're just in the middle of very substantial changes. I mean a lot of the inflation pressure, the price pressure that you mentioned was created, well first of all we had a wave of tariffs last year, remember that? And then obviously the whole crisis, the war in the Middle East, which triggered energy and that also has been having an impact on headline inflation, not so much on other parts of inflation. So the spillover has so far been quite limited. And if you look at other mixed or other economic data, the signal is quite mixed. Yes, we did have a series of relatively strong pre-old numbers, but at the same time, employment components within other business services like the ISM manufacturing, the ISN service, or particularly also small business survey, Hiring intentions. Basically at the lowest in a decade, if you exclude a few months during COVID. Capex intentions, the lowest since 2009. So it's not clear where, let's say, it's not, we're not in an overheating economy per se. So I think it's the right thing to emphasize price stability, to signal the willingness to high grades. But just to do it right now seems to be a bit. So a bit more time is no bad thing, but I mean, how do you think that, I mean the Fed is unusual in having this kind of dual mandate, full employment and stable pricing. Is it an asymmetric balance there? Is it, you implied earlier that you think the price stability is a thing that should or will dominate. Is that really how you see it with... Well, that's generally what I think central banks should do. I mean, they were created to manage monetary policy, which means they should keep a lid on price pressure or actually keep price stability. Now, of course, that always came with a tag. That doesn't mean that they should create recessions or they should create massive spikes in unemployment. That's how the dual mandate came across. But clearly price stability, monetary policy. To create a stable price environment is at the core of every central bank. So yes, I think, and that were Warsh's words himself, I mean, they have maybe deviated a bit too much away from, from guaranteeing price stability, having failed five years in a row, failing six years in a roll. So yeah, I thing moving back towards putting more emphasis on price stability is the right thing to do. And I think that's what we have to expect from Kevin Warsh. At least. Based on what he said during the press call. So on the build up to his nomination, he was quite vocal about why he wouldn't be hiking rates. And that was centering upon the notion that all this IT spend, the AI was going to lead to big improvements in productivity. And therefore, as a result of that, actually that was going to take away some of the worries about bad inflation. Has that view changed? He didn't mention productivity, we kind of touched on that. Is he really a believer or? How is he balancing this? How do you think he'll play? Will he allow inflation to run hotter, even given what we've just said, because at some point he truly believes that productivity will kick in. Well, obviously it's hard to say, because as you mentioned, we have these two statements. One is the actual statement and one is the non-statement during the press conference, which was also a bit striking. I mean, he didn't push back against some hawkish members or hawkic comments, which he did before he became the Fed Chair. So personally, I think he is a believer. I am a believer, I do think AI will be here to fundamentally change the way we work, the way economies function. By increasing productivity, which kind of puts a lid on inflation to some degree. But that's a longer-term issue. You mentioned it yourself. Now, the Fed has to take both into account the longer-terms structural changes, but also the short-term potential spillovers. And there we have more good news. I mean, inflation expectations, short-term and mid-term and long-term, have fallen quite substantially. That's another signal for me that means the Fed have more time to wait. For example, is the labor market really as tight and as strong as payroll suggests or is it maybe just another distortion that we have seen many times? So I do think he is a believer, but I do you think he's serious about price stability. But being serious about both of these issues doesn't mean you have to act immediately because both are longer term issues and I think they still have the time to wait for more incoming data. Now we also said that we believe that market pricing is really important and it gives us a good indicator of what could or what should happen. You could also argue it's a constraint on many of the policymakers as well, depending on what the bond and equity markets are doing. If I look at the pricing and the rates market today, and certainly following the speech, it shifted. The market is telling us that he's going to hike two times before the end of the Thank you very much for your attention. Thank you all for being here. That's not how you interpret it. So is he being confusing? Is the market simply wrong? Or do you think that you may have to modify your view? Well, look, clearly, I mean, following the series of relatively robust labor market data and then particularly also the Fed statement and Kevin Warsh's press conference. So it's not only about Kevin Warsch. I mean as I mentioned, nine members have shifted from no rate changes or no changes to higher rates. Now I also think that this obviously was still under the impression of everything that was happening. I mean energy prices spiked. And we have seen some. Sticky price inflation in other areas. But that could change again. And my view is exactly that probably the market investors, maybe even some of the Fed members have been carried away a little bit. And I would expect based on quite a number of surveys and other data that we are about to see maybe less inflation pressure, lower price pressure. I mean, energy prices have fallen substantially. Even the labor market tended to be quite light in summer months. Remember Particularly around youth unemployment, we have seen a little bit of an elevated level over the past few summer seasons. So maybe that happens again, which means there will be several reasons why the Fed does not have to rush into rate hikes. But to your question, clearly the risk of rate hike or of tighter monetary policy has increased. I'm currently keeping my view of no changes this year, but the risk having to be adjusted clearly has increased Just going back to these task forces that we have, I mean, you mentioned there's five of them. We spoke about a few of them, including the communication side. Is this for show? Is this, you know, you come in, you show you've got all these committees set up and task force set up, you take on board their findings. What changes? Do you think there will be real change? We've seen some of the communication points, as you have mentioned, but is this to kind of clear the deck and start again or? Is this more for show to be seen to be going through the process of reviewing the feds mandate and how it functions? No, I honestly expect some of these task force to come up with proposals and solutions that eventually will lead to changes within the Fed. I mean, we did see the communication part has already changed even before the task force was set up. The balance sheet has long been a topic that Kevin Warsh was concerned about or was kind of interested in, so I'm also expecting some results there. Another task force deals with better ways to get data. I mean. Well, we're living in 2026 now, I mean, we do have all sorts of real time data, we can use AI maybe to support our models. So I think it makes sense to think about, is the Fed still working on the right basis? Are there better ways to get incoming data to get closer to the business cycle? So that's another one that absolutely makes sense. The other inflation framework, I think that's more of a general review. Probably every incoming Fed share had a review of the inflation framework. Within that task, what I expect is a discussion maybe around the inflation target, quite a crucial one. Remember, having failed for five years in a row, there was always discussion, would an incoming Fed maybe just lift inflation target to, let's say, 3 percent? I mean, that would be kind of the easy way out. But Kevin Warsh, again, was actually explicit on that one and said, look. Before reaching the actual 2% target, it doesn't make sense to increase the target to 3%. And I fully couldn't agree more to that because doing so while not having reached the former target would really undermine credibility. So that is the one that I would expect them to follow up as well. So those are really task force, they make sense and that doesn't mean they change everything that will be analyzed and looked at. But some things probably will change, some ways the Fed works or gets data probably will change and I still expect also to the better, to a more efficient way to monetary policy in the US. Now Jay Powell has stayed on at the Fed, no longer chair, but he's still part of the committee, and part of argument for him doing so was he wanted to make sure the institution was as strong as it can be. He obviously was pushing back against the threats made towards the independence of the Federal Reserve. How long do you think he stays now, and does he have any impact in terms of the workings of the Fed? I mean, if you take at face value, as we do what Warsh said, you would probably say it's in... In safe hands. So is there now time for Powell to move on? And who would be the next member? Would that change that dynamic significantly at all in terms of the Doves versus the Hawks? Well, look, first of all, I don't think that you're right. I mean, I think as we discussed, I mean the messaging coming from Kevin Walsh certainly is positive, probably should be taken positive by Jay Powell. Nevertheless, I do not think that he now just turns around and quits. I mean being one of the few exceptions of former Fed chair basically stepping back but still remaining on board just for a month, I dont think that makes sense. So I wouldn't expect him to now just... To resign in the coming weeks and months, so probably he's here to stay to see whether really the Fed actually has the stability, has the credibility that really is close to his heart. So, I wouldn't expect any changes soon. He certainly has an influence because he's a very experienced Fed member. He obviously was the Fed chair for a number of years. But also according to Powell himself, he doesn't want to play a leading role. I mean, we don't. See all the inside works of the Fed, but I do think he's truly honest about him being interested in the wellbeing of the fed itself, for that stepping back, but taking up his role as a serious Fed board member. So I think that definitely is to the benefit of Of course, by staying on, he squeezed out Mirren, another Trump appointee, who was not only dovish in rhetoric, but in terms of his vote, he was voting for rate cuts. So that is something, again, we don't expect him to be coming back anytime soon, or is that? No, I wouldn't expect him to be back. I mean, unless obviously we get a vacancy in the board, but I agree that may or may not have been one of the main reasons for Powell to stay, but clearly it was a result. But quite honestly, I mean you can agree or disagree with Stephen Mirren's view of the world and monetary policy, but he clearly was kind of an outlier with regard to his vote and with Powell staying on and Mirren now leaving to make place for war, that probably... Brought back the comedy closer to maybe a consensus. Tom, you've put this paper out. I think it's obviously really important because so much hinges on the Federal Reserve, so much hinge on the credibility of the Federal Reserve. Just to round this off, what are the key takeaways? What are the key things that as investors, as people who have exposure to US interest rates, what is the messaging that you would want to convey here? Look, there's a couple of points. I mean, first of all, I think the key takeaway is Warsh does not intend to be just a yes man and just coming in as the dovish Fed chair that he was perceived to be or potentially perceived to, he wants to be independent. He wants to emphasize the Fed's credibility. He wants work on that and to do so, they need to work on reaching the price target, the inflation target. I truly think that's one of the key takeaways. Which also means that the Fed might act a bit more hawkish than many believed, even at the beginning of the year. And I think the third takeaway is, again, we briefly mentioned it, probably less transparency, less forward guidance, which means a bit of more volatility, which is not necessarily a bad thing. It allows a more open discussion, a more opened price-finding process, and I think those are the key takeaways I would have from this. .[Music starts] Great. Well, I think it's some really interesting insights in there. I would encourage all our viewers to take a look at the paper, read it through, give us your thoughts, opinions. Do you agree? Do you disagree? What's your thinking around that? So we appreciate taking time to watch us today. Please read the paper and as always, like and subscribe and you can see our full publications, as always on Zurich.com.[Music ends]