The new chairman of the Federal Reserve, Warsh, pushes for the reduction or even abolition of the forward guidance on interest rates. Mainstream asset management warns that market uncertainty is rising, and both U.S. Treasury volatility and borrowing costs may rise in sync.

Source: Jinshi Data

Last week, newly appointed Federal Reserve Chairman Kevin Warsh hosted his first interest rate meeting, announcing the start of a "new phase" in the Federal Reserve's policy communication. He plans to reduce or abolish certain forward guidance tools and will no longer provide clear signals about interest rate direction to the market in advance. This move has prompted a collective warning from major investment institutions that it may exacerbate volatility in the U.S. Treasury market and raise borrowing costs across society.

This FOMC meeting maintained the benchmark interest rate, while the policy statement was streamlined to remove the long-standing guidance on monetary policy easing or tightening. Warsh also refused to submit his personal interest rate dot plot expectations for this year and the next, while the other 18 officials published their dot plots on time. Institutional investors stated that the absence of the chairman’s expectations would significantly weaken the guiding value of the dot plot for the market.

Bob Michele, Chief Investment Officer of Global Fixed Income, Currency, and Commodities at JPMorgan Asset Management, expressed his disagreement with this reform: "The decline in transparency offers no positive value; the market will only fall into more speculation, increasing uncertainty, and both risk premiums and event-driven volatility will rise simultaneously."

Warsh acknowledged that this wide-ranging adjustment requires the financial markets to digest and adapt, but he clearly has no plans to withdraw the reform plan. A special working group will be established to study further reductions in guidance, or even the complete abolition of the dot plot.

He had previously stated that the dot plot and forward guidance hinder the Federal Reserve's ability to adjust policies, making it easier for the central bank to cling to outdated forecasts and amplify policy errors. Now, the market relies excessively on official guidance, with asset pricing closely aligned with the Federal Reserve's views, creating an information echo chamber that loses independent pricing logic.

Currently, U.S. Treasury yields have been rising steadily, influenced by inflation and interest rate hike expectations stemming from the conflict in Iran, with the 10-year Treasury yield rising 50 basis points this year; the 2-year Treasury yield, highly sensitive to monetary policy, has risen to 4.22%, reaching a one-year high. Institutions believe that communication mechanism reforms will further push up yields.

Calvin Tse, Head of Strategy and Economics at BNP Paribas, stated: "The market is more likely to encounter policy surprises in the future, and the trading side needs to account for a higher interest rate hike risk premium, leading to a systemic rise in overall volatility."

Several days after the interest rate meeting, risk premiums had not significantly increased, with the market generally waiting for the special working group to release a complete reform plan.

Tiffany Wilding, an economist at Pacific Investment Management Company (Pimco), predicts that subsequent adjustments will exceed market expectations, including reducing the number of press conferences, decreasing standardized policy statements, and actively creating surprises in the bond market, ultimately amplifying interest rate volatility.

Divergent Views: Volatility Rising Holds Negative Impacts but Aligns with the Federal Reserve's Inflation Control Goals

Forward guidance was born in the zero interest rate era following the global financial crisis. After short-term interest rates reached their lower limit, the Federal Reserve relied on guidance to steer long-term interest rates, stimulating inflation and economic growth.

Former Federal Reserve Chairman Ben Bernanke introduced the interest rate dot plot in 2012 to convey long-term low interest rate signals to the market. Now that policy rates are high, the questioning of the dot plot's practical value is increasing, and opinions on this reform's pros and cons are markedly divided.

Pramod Atluri, a fund manager at Capital Group, suggests that rising volatility and borrowing costs objectively align with the Federal Reserve's inflation control demands: If market expectations are overly certain and volatility is completely smoothed out, funds will heavily leverage for speculation, raising asset bubbles. Higher yields and volatility will raise leverage costs, tightening the financing environment for enterprises and households, thus suppressing inflation from the demand side.

Some institutions added that retaining space for policy surprises can strengthen the effectiveness of the Federal Reserve's policy transmission and enhance the central bank's influence on asset prices.

Rick Rieder, Chief Investment Officer of BlackRock Global Fixed Income, believes that there should be a power imbalance between the central bank and the market: Moderately creating policy surprises during an easing cycle can activate market risk appetite and boost economic vitality.

Macroeconomic Hedge Funds Welcome Volatility, Short-term Trading Brings More Arbitrage Opportunities

Macro hedge funds relying on volatility profits from bonds and foreign exchange view this communication mechanism reform as a long-term positive. In an environment where the Federal Reserve no longer releases signals about interest rate changes in advance, accurately predicting the policy path will bring significant excess trading returns.

The Financial Times, citing participants at a New York industry dinner, reported that several macro fund managers reached a consensus that Warsh's new communication framework will continuously elevate market volatility, creating more opportunities for swing trading.

Kelly Tropin Whitridge, Chief Economist at the $21 billion macro hedge fund Graham Capital in Connecticut, analyzed: "The Federal Reserve's intervention in market expectations has significantly declined, and the volatility center will rise over the long term. Short-term interest rate trading is already our core business, and its weight will further increase in the future."