Many of you may remember the late Alan Greenspan. He was the 13th chair of the Federal Reserve, serving in that role from 1987 until 2006. For the most part, he was tight-lipped on what the Fed would do when it came to interest rates.
When he would head into work at the Marriner S. Eccles building in Washington D.C., Greenspan carried a briefcase with him. A briefcase that became financial lore with every passing year.
The infamous briefcase, Source: Forbes
The running joke was that the thickness of his briefcase was a clue as to what the Fed was about to do. The thought was that a thicker briefcase meant he was carrying a ton of charts and data. That way, he could convince the Federal Open Market Committee (FOMC) members to vote to hike interest rates.
But if the briefcase looked thin or empty, investors could relax. That meant the Fed would leave rates unchanged. Or maybe even lower them.
Over the years, the briefcase indicator took on a life of its own. So much so that networks like CNBC would zoom in on the briefcase every time Greenspan walked into work.
What does the briefcase say?
They even had segments providing commentary on the briefcase.
In reality, the thickness of Greenspan’s briefcase had nothing to do with Fed policy. He even joked about it saying it depended on if his wife packed him lunch that day.
But at the end of the day, it was all in a bid for traders to try to get some sort of edge on the Fed’s next move. If they had an idea of policy moves, they could make fortunes.
Forward Guidance
Up until Greenspan’s departure, the Fed didn’t tip its hand on its policies. This was by design. It gave the Fed flexibility to do what it thought best for the economy at the time.
But that all changed when his successor, Benjamin S. Bernanke, took over.
Bernanke – or “Helicopter Ben” as I like to call him – changed the way the Fed communicated with the world. He loved the camera. And he loved to tip his hand on the Fed’s next move.
In a break from decades past, Helicopter Ben introduced “forward guidance”. He basically told investors in real-time what the likely future path of rates would be.
And he even penned opinion pieces telling everyone exactly what he was going to do.
Like his op-ed in 2010 for the Washington Post.
At the time, fear still ruled the roost. People wanted almost nothing to do with stocks. They certainly didn’t want anything to do with real estate.
Anything risky was just about off limits. Everywhere you turned – on TV or in print – it was all about safety. It was all about fear.
But good ol’ Helicopter Ben knew something different. He knew he was about to light the markets on fire.
In his op-ed, he went on to say:
“[…] higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
He told everyone the playbook.
Buy stocks. Buy houses. Buy everything and don’t look back. The open communication, the forward guidance…it was a signal. One that made it easy for traders to cash in.
The rest is history.
And ever since Helicopter Ben lit the fuse, his successors – Janet Yellen and Jerome Powell – followed his lead. It was a new age of “forward guidance” that made it easy on forecasters…and easy for investors to benefit.
But that’s all about to change.
There’s A New Sherriff in Town
Kevin Warsh isn’t afraid to mix things up.
The 17th Chair of the Federal Reserve, Source: Federal Reserve
The new Chair of the Federal Reserve isn’t shy about what he believes the Fed should be versus what it is today.
Which is why his first press conference as Fed Chair last month was important. Some of the things he discussed were continuations of criticisms he made of the Fed in the past. And it set the tone for what we should be looking for throughout his tenure.
One of the things that Warsh is critical of when it comes to Fed policy is the “PhD driven models” the Fed uses. Like the Phillips Curve.
If you’re not familiar with the Phillips Curve, don’t worry. You’re not alone. All it says is that in the short run, lower unemployment comes with higher inflation. So a tight labor market can push wages up and companies pass on those costs to consumers.
This theory is central to Fed policy…At least for now.
But it has nothing to do with actual market data. And it strangles growth before it’s ready to breathe.
Which is why Warsh wants to take a hammer to the Phillips Curve and other policies like it.
But it’s more than that. In his press conference last month, Warsh told investors and analysts something even more critical. He said the Fed will no longer publish forward guidance.
That means the party’s over for the easy path to Fed watching. We’re going back to the days of briefcase watch. Something that I believe is long overdue.
No more easy interpretation of what the Fed will do next. No more hand-holding. Warsh just told investors they’re big enough to play on the monkey bars without any help. Don’t slip and fall. Good luck!
Going further, Warsh set out five key areas that he wants to reset at the Fed. The first being communication, or how the Fed talks to the public.
Forward guidance is part of that. And the infamous dot plot – which shows what the Fed governors think as far as interest rate changes in the future – is another. Warsh even stopped submitting his own “dot” arguing that individual projections aren’t helpful. In fact, he thinks they’re misleading.
Second, is the Fed’s balance sheet. He wants to reassess the size and structure of it.
Third is about the data the Fed uses. He wants to find better data that’s more current. Data that’s far better to help make decisions than the data the Fed’s army of PhD’s use today.
Fourth is productivity and jobs. He wants to see how AI affects productivity and labor markets. Something he believes will be a powerful, disinflationary shock that will allow for fast growth with lower inflation. (That could ultimately mean lower interest rates.)
Finally, Warsh thinks the Fed needs to revise the way it looks at inflation. It’s outdated at best. And it plays a huge role in Fed policy.
I agree. In fact, I think there’s a far better way to look at inflation that’s more in-line with real-time prices. (More on this later.)
Warsh isn’t the status quo Fed Chair we’re used to from years past. Things are changing. And what you do next with your money will have implications for how your portfolio may perform in the coming years.
Something I’ll talk about in the next issue of Strategic Edge. Don’t miss it…
Regards,
Editor, Strategic Trader