Former senior Fed advisor Jon Faust said he does not expect the Fed to raise interest rates at its Federal Open Market Committee (FOMC) meeting, which concludes today. Faust shared the view that the Fed would not try to gain credibility by deliberately surprising the market.
In his assessment today, Faust noted that Fed Chairman Kevin Warsh has used strong rhetoric about restoring price stability but has largely failed to share details on how he plans to achieve it.
Faust stated that this communication gap led to different scenarios being put forward in the markets, drawing attention to comments suggesting that Warsh was hiding his hawkish views to avoid a reaction from US President Donald Trump, that FOMC members were limiting Warsh’s dovish tendencies, or that the Fed Chairman wanted to carry out a surprise interest rate hike this week in order to be able to make a more dovish shift in the future.
However, according to Faust, the reality is simpler. Faust notes that Warsh, at least since his confirmation hearing, has presented himself as a pragmatic policymaker on the hawkish side of the centrist line, adding that the Fed Chairman places strong emphasis on monetary policy communication but takes a more flexible approach to the scale of balance sheet reduction.
Faust also said that Warsh did not adhere to fixed rules or specific economic models for monetary policy, but rather believed that more effective results could be achieved by improving the decision-making process.
Faust likened Warsh’s approach to the policy philosophy used during the tenure of former Fed Chairman Alan Greenspan, which David Wessel described as a “sophisticated intuitive approach.”
Faust stated that, unlike strict monetary policy rules, this approach does not produce clear results regarding interest rate decisions, and that under current conditions, both a 25 basis point interest rate increase and waiting until the next meeting could be reasonably defended.
Faust stated that, in line with market expectations, he predicted the Fed would choose to wait today, and offered the following assessment:
“I think the option value gained from waiting will outweigh the negatives today. One reason for this is that I agree with FOMC Vice Chairman John Williams. I don’t think the possibility of gaining a credibility boost by deliberately surprising the market will play a role in the decision.”
Faust also argued that there is no major macroeconomic difference between the Fed raising interest rates today or keeping the policy rate unchanged. According to Faust, a 25 basis point higher or lower rate for eight weeks alone will not create a decisive economic impact.
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All eyes will be on Warsh’s statements.
Faust added that what would be important was not the decision itself, but how it would be explained to the markets.
Faust noted that Warsh has so far argued that monetary policy should be forward-looking, but has not offered much guidance on economic forecasts or the likely trajectory of interest rates, adding that the limits of the Fed’s communication strategy are not yet fully known.
Faust warned that if the Fed does not explicitly state that it sees rationale for raising interest rates but prefers to wait for more data, misinterpretations of the decision’s meaning could spread in the markets.
According to the former Fed advisor, whatever decision is made today, how Warsh explains the monetary policy decisions at the meeting and the subsequent press conference may be the most important information investors will glean.
*This is not investment advice.
