Fed Communication and Inflation Risk (with Jonathan Ferro, Lisa Abramowicz, Annmarie Hordern)

Former NY Fed President Bill Dudley criticizes Kevin Warsh for not disclosing the Fed's monetary policy reaction function. He argues markets need to understand how the Fed will react to changing conditions for policy transmission to work efficiently. Dudley sees a compelling case for tighter policy: rates have been at current levels for 3 years with unemployment at 4.3%, and financial conditions are accommodative with the highest impulse to growth since late 2021/early 2022. He aligns with hawkish Fed voices but notes June inflation data will likely improve due to declining oil prices.

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Former New York Federal Reserve President 2.5
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Bill Dudley 8.5

Fed Communication and Inflation Risk (with Jonathan Ferro, Lisa Abramowicz, Annmarie Hordern)

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Tighter monetary policy typically strengthens the dollar. Dudley argues for rate hikes which would likely support the dollar.

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The case for monetary policy becoming a bit tighter is pretty compelling. I'm aligned with Alberto Musalem and Lorie Logan.

Kevin Warsh making changes at the central bank - limited forward guidance, creating task forces, putting more weight on financial market signals. Bill Dudley wrote a fresh look is appropriate but needs greater care.

Jonathan Ferro
Bill Dudley

I'm fine with getting rid of forward guidance but concerned Warsh is not disclosing the monetary policy reaction function - how the Fed would adjust as the economic environment changes. Relying on financial markets won't work because markets price to what they think the Fed will do.

Monetary policy works through financial conditions. If markets don't understand what the Fed is doing, transmission slows and becomes less efficient. You need to provide guidance about how you'll react if things evolve differently.
Warsh seemed to find it difficult to separate forward guidance from articulating a reaction function. Why is that difficult?

Jonathan Ferro
Bill Dudley

It's straightforward. Forward guidance is saying what we expect to do next. The reaction function is about how we would react to different incoming information. He needs to distinguish between those two things.

The job of monetary policy is the Fed's job, not the market's job. Task forces have a finite life - they're not a replacement for communicating how the Fed will act as conditions change.
Do you think it's appropriate for the Fed to hike at least once, if not twice or three times this year?

Annmarie Hordern
Bill Dudley

The case for tighter policy is compelling. We've been at this rate level or higher for 3 years and unemployment is still 4.3% - where's the evidence policy is restrictive? Financial conditions are accommodative with the impulse to growth over 1% positive - highest since late 2021/early 2022.

I'm aligned with Alberto Musalem and Lorie Logan. But this is probably the last bad headline inflation report for a while - with declining oil prices, June CPI and PCE will decline significantly.
Isn't what we have highly restrictive for housing?

Lisa Abramowicz
Bill Dudley

Housing isn't doing well mainly due to lack of demand from no labor force growth, hence no household formation. Mortgage rates at 6.5% aren't particularly high historically. The lock-in effect from low rates doesn't reduce housing demand since movers demand another house.

The big question for housing affordability is zoning and land use to allow more homes to be produced. Increasing supply would weigh on prices. It's not really a big interest rate problem.
How easy is it to change the Fed institution?

Jonathan Ferro
Bill Dudley

There's inertia - staff will be there longer than Kevin Warsh. But you can move things with a better mousetrap. My mantra was 'best idea wins' - if Warsh and the task forces come up with better ideas, those best ideas will win.

The staff has tremendous expertise and pride in their work. They subscribe to the best idea winning regardless of where it comes from.

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