Joseph Wang: Again, I expected Kevin Walsh to be the Kevin begging for the job. He came out and he was like the Kevin that you always knew was there. So, I think it was a pretty hawkish. I think that the market reaction is in line with the hawkish Fed. He has been a champion of having less Fed communication and he put that into practice right away. Maybe we don't need an SCP. Maybe we shouldn't even have Fed presidents talk so much. Maybe we don't even need that many press conferences unless I have something to say. All the task forces are laying the groundwork for huge changes that are coming out to the Fed. You could actually have a significant consolidation of power within the Fed chair. What really stood out to me is this last sentence that where Kevin says the committee will deliver price stability. What you usually see in major tops is rate hikes. Now, we didn't hike rates now, but market is pricing at a hike. So, you got all these things coming up together. I think they all point to me to a

Jack Farley: nothing said on for guidance is a recommendation to buy or sell any investments or products. This podcast is forformational purposes only and the views expressed by anyone on the show are solely their opinions, not financial advice or necessarily the views of Blockworks. Our hosts, guests, and the Blockworks team may hold positions in the company's funds or projects discussed. As always, investments in blockchain technology involve risk. Terms and conditions apply. Do your own research. All right, everybody. Welcome back to another episode of Forward Guidance. And we are recording on a very special day today, June 17th, right after the first FOMC meeting from the new chair, Kevin Worsh. No one I'd rather be with right now than Joseph Wang, Fed Guy. Joseph, you're you're the man of the hour for this type of stuff. Great to have you on the show.

Joseph Wang: Thanks for inviting me, man. It's great to be back.

Jack Farley: Yeah, great to be back. Um, we got to we got to talk about uh how many times people said they hate the name of this podcast now or at least Kevin Worsh did. So I see so many jokes about you know forward guidance is over. Um

Joseph Wang: going to change your name now.

Jack Farley: I know we got to rebrand or something. You got to be a maybe change it to task force might be the new name for the podcast after how many times he said it. So um yeah I mean we knew that was going to happen. He's he's been a big critic of of forward guidance. We're going to we're going to spend the other specifics from the SCP and the the press and the press conference after.

Joseph Wang: Yeah. So his statement was surprisingly brief like you mentioned. So historically speaking, Kevin has always had uh you know disagreement with how the Fed communicates. So the Fed communication has changed a lot over the past few decades. Few decades ago under chairman Greenspan it was there was basically no communication. The market had to guess what the Fed was doing. And then under Bernanke and Yellen, they started to communicate a lot and they introduced forward guidance. They would tell you what their plans were for interest rates for years to come so that that smoothed out things for the market. But Kevin thinks that you shouldn't do that because the world is very uncertain. And if you make a promise to the market, and things change because of inflation or war, you're put in a position where you either break your promise and damage your credibility, or you're locked into doing the wrong thing. So, the best communication is to promise nothing at all. And I think he really put that into practice in today's statement. If you look at the brief one page statement that he put out, it just says what's happening now, and basically zero guidance about what the path is forward. That is very in line with his style of you know less is more. Although we did get some dot plot projections. And so, the market did perform very interestingly today to the point where after this meeting, we are actually priced in a bit more hawkishly than before.

Jack Farley: tur 100%. Um, of course, they didn't actually hike rates or do anything today in today's meeting. Um, it was an SCP meeting, summary of economic projections, and the rest of the FOMC committee submitted their dot, their forecast, but of course, Kevin Worsh did not. So, we we don't actually know what he expects or whether he thinks there'll be a hike this year, or even next year. But it's really interesting because from that dot plot, like you noted, it was hawkish. Like last time they were expecting two cuts, and now the dot plot is actually expecting a hike or two by the end of the year. So how do we square that? How do we square the fact that we didn't actually get any sort of hike despite them saying that?

Joseph Wang: So, I think notwithstanding the effort to get rid of forward guidance, Ford guidance is still there, right? We still have the dot plot even though it was not in the language statement. don't have to change the name of the show just yet. But through that dot plot though, you can see that the rates market reacted immediately to what both the statement and the dot plot. And you can see that the market is now pricing in a little bit more than one hike this year. So the entire curve basically shifted upward. The third the long bond actually went went down a little bit. Uh but the the front end and the and the belly went up a bit in rates. And so that tells you that the market is actually already tightening a bit. So he he didn't have to actually hike. He did tighten financial conditions and race rates just by his communication. And I think if you take a step back, it's really remarkable on this journey we've had over the past few months. Right? We enter the year with the market pricing in a few cuts and then boom, we have the war with Iran. oil prices go up, inflation surges and the market began to price in price out those cuts began to price in hikes and even after uh the recent resolution when we have oil prices come down the market still is pricing in some hikes. So there it's been quite a quite an evolution over the past few few months.

Jack Farley: Mhm. Yeah. I mean, it does still seem like the the dot plot has a lot of power because I mean, if you just look at the price action in the two-year, a lot of the selling off there and the pricing in of those hikes seem to have occurred right when the SCP came out before the press conference. Um, seems like a lot of the hawkish reaction to markets actually mostly came from that. And you know, I'm trying to square out like how much of this was just the FOMC and the dot plot marking a to market where the sofur market has been for for a couple weeks now. Like we've we've had a hike priced into the curve by the end of the year for a little bit now and now it seems like the SEP and and the Fed is just getting to where the market has already been. Is that is that sort of how you see? Obviously, there's been a little bit more of a further excessive reaction. you can just see in the two-year, but it feels like it's more so just meeting where the market was already at. Do you see it that way?

Joseph Wang: Well, I mean, we're a bit more hawkish than they were a few days ago. So, so the sofa market prices in what it thinks the Fed reaction function will be and I think it's going to have some difficulty right now as we transition from one Fed chair to the other. Now, going into this meeting, I actually would not have expected it to be this hawkish. Uh the reason being that if you listen to what Kevin has been saying when he was auditioning to be a Fed chair, he was doing everything he could to try to justify rate cuts, right? First it was about AI productivity and then it was like you know the CPI PCE that's just not a good measure. A really good measure is trim mean PCE guys and it's telling you that inflation is coming down. So he was doing everything he can to do that. And then you had all these other people who were like, you know, the standard way that we approach these negative supply shocks, these energy shocks is to look through them. That's what the Fed did during the Iraq war. That's what the Fed did during Operation Desert Storm in the 1990s. Standard central banking. Now, you had some people began to mumber that, you know, we've had too many supply shocks. We got COVID, we got tariffs, we got oil, we can't keep looking through this. But we had huge declines in oil prices in the past few days. So if you still had that same Kevin who was campaigning for um you know rate cuts, if you had still had stand standard central banking operating measures, you would have expected with oil prices coming down, they could actually look through this, especially since the most recent CPI data, if you if you look at month-over-month core, it was actually a pretty tame 0.2%. So they had enough cover to look through this and so deliver something that was at least not hikes but maybe just affirming the current current rate but they didn't do that and so I think the market is learning about what this new Fed reaction function is and at the moment it's tilted to be a bit more emphasize a bit more on inflation so a bit more hawkish.

Jack Farley: Um based on that reaction function do you think these hikes actually happen? Um the committee is pretty split, you know, like nine of them are talking about hike. We don't actually know really where Worsh is. So there's a disconnect between what is priced in and what actually happens. Do you have do you have any thoughts there?

Joseph Wang: No, I don't think we'll hike this year. So

Jack Farley: yeah,

Joseph Wang: on the one hand you can energy prices are coming down. Uh they're going to come down maybe rapidly and so that is going to have a disinflationary tailwind coming forward. you know why would you be hiking if you don't need to? and furthermore, if the market has already done the job of tightening financial conditions for you by pricing the two-year to over 5%, you don't need to hike. If you start actually hiking you might break something. You can just enjoy the work that the market has done for you. And if they can successfully hold inflation down or if like I expect oil prices continue to drift lower and that pulls down inflation, then the need for a hike completely evaporates. However, what it does show I think is that the threshold for a cut is very high under this new Fed. Whereas we entered the year expecting cuts, now not only are cuts off the table, but even if inflation begins to behave, they probably just want to hold rates here for quite a while to make absolutely sure that inflation doesn't rise again. So, but my base case is that we just hold rates throughout this year.

Jack Farley: Yeah, 100%. Um, all right. So, during the press conference, one of the big announcements was these new initiatives or task forces that Kevin Worsh announced that he was going to pursue that go across a few different key themes. And yeah, I would love to just unpack each of them because I do think they are pretty consequential for how uh Fed watchers such as us and just the broader market think about things. So the first one is around communications. So obviously as we've already talked about um Wars has been a stern critic of the usage of forward guidance. Um it you know it's a lot of it's pretty notable for how the Fed communicates. I mean I think in his opening statement he actually mentioned like you know we can't be held hostage by our forward guidance. which is interesting because historically the Fed has tried to guide market expectations months in advance to prevent volatility. And now he seems to be saying, you know, we're going to let the data lead. Does that mean we're going to have a lot more volatility in the path forward? And regarding the task forces themselves, I mean when an organization sets up a task force, it's either because they want to make a big change, or because they want to delay making a decision so they set up a task force to study it. Which one do you think Worsh is doing here?

Joseph Wang: It was them.

Jack Farley: It was them.

Joseph Wang: It was them. They got the promotion, they got more headcount and everything was great. Okay, so this is how things work in bureaucratic organizations. You need cover when you want to make big changes, right? Like reorganizing how the Fed communicates or reorganizing how the Fed operates, you can't just do it alone, you need a task force. Because the Fed itself is a huge, conservative bureaucratic organization filled with thousands of economists. If you just walk in as a new chair and say 'we're going to get rid of forward guidance, and we're going to do this and that,' they will resist you. If you want to get them on board, you have to bring them into the process. So you create a task force, bring people from different regional Feds and the Board together. Then you discuss, and eventually present reports and recommendations. Because the task force is made up of Fed insiders, they feel like this represents their own opinions. Then you adopt and implement reforms based on that, which is how bureaucratic organizations implement major changes. So I think these task forces are not meant to delay decisions. They are the prelude to major changes that are happening. This is also why I mentioned we could see a significant consolidation of power within the Fed chair. If you look at how the Fed is structured now, it has a lot of Fed presidents, like 12 regional Fed presidents, and several governors, and they are constantly giving all kinds of speeches in public. Over the past few years, you would hear one Fed president say we should hike rates today, and the next day another one says we should cut. This confuses the market. Kevin has always been unhappy with this messy communication from the Fed, believing it creates unnecessary market volatility and damages the Fed's overall credibility. Therefore, I wouldn't be surprised at all if this task force ends up recommending limiting public speeches by regional Fed presidents, or requiring all policy-related commentary to be centrally cleared by the chair's office. This way, the Fed will speak with only one voice, which is Kevin Worsh's own voice. This is a huge consolidation of power for the chair personally, but in Kevin's logic, this is crucial for improving communication efficiency and stabilizing market expectations. Thus, the future Fed may no longer have so many conflicting speeches, and all communication will become very cautious and disciplined. This will indeed lead to a certain increase in market volatility because the market can no longer get exact interest rate path hints far in advance and must judge independently based on data. But as Kevin said, this is how a healthy market should behave. So maybe that's that's one thing that could happen. There would be more rate volatility. But as a Fed chair that is probably not super popular and maybe want to do things that most people don't agree with, I would like the other people who disagree to not be hurt. So maybe that's that's one thing that could happen.

Jack Farley: Yeah. I did want to ask you about the impact of this lack of guidance on ratev b for financial market participants. Because for a long time, because the Fed worked so hard to smooth out volatility, a lot of institutions and traders got used to operating in a low vol environment. If the Fed really stops providing forward guidance, interest rate volatility will certainly rise. Would that make some people who have current strategies uh relying on lowval unhappy.

Joseph Wang: Yeah. What about the basis traders like that? I imagine like that is just so much reliant on stable short-term funding costs, like repo market stability. If the Fed stops providing forward guidance, and funding costs become more volatile, then the risk for basis trades rises exponentially. What do you think about that? You've written plenty of times about it. Um I imagine this could be pretty dicey for them.

Joseph Wang: If it were to become very more volatile, funding costs would be more volatile. Yes, as we've seen before, when liquidity tightens, or when Fed policy intentions are unclear, repo rates and SOFR can spike. For basis traders, even a few basis points of fluctuation, amplified by extremely high leverage, can be a major threat to their returns or even survival. So that is indeed a potential risk point. We're watching closely to see if the Fed will have specific mechanisms for this. But right now, it's still early stages in his reign.

Jack Farley: Yeah. Too early to tell for sure. Um, all right. The the other major task force mentioned in the FOMC statement was this commitment to the ample reserve regime. Um, which is very interesting for those of us who follow the liabilities side of the Fed's balance sheet.

Joseph Wang: yeah on that why would he say that? Right. that's kind of very much in the background. I mean just just for reference you know that over since last December, the liquidity conditions at the Fed have been tightening. The RRP balance fell from over $2 trillion, and reserves have fluctuated downwards. And Worsh stated that the Fed will continue to maintain the 'ample reserve regime,' and set up a task force on liquidity and reserves. This makes me think that the Fed is starting to get alert to the potential risk of liquidity depletion. Because under the ample reserves framework, the Fed needs to ensure there are enough reserves in the system to prevent bank funding spikes, like what happened in September 2019. But as for 'what level is ample,' there's no exact number. So, is this task force created to better assess current liquidity conditions, or does it imply new changes to the Fed's quantitative tightening (QT) policy? This is just the beginning of big changes that will come maybe within a year or two. From the Fed's toolkit, if they want to maintain tightness without hiking, adjusting liquidity tools is a way. But whether money is currently scarce, views are divided. Some think reserves (around 3.2T to 3.3T) are nearing the lower bound of 'ample,' while others think with the Standing Repo Facility (SRF) as a backstop, liquidity is still abundant. Worsh setting up this task force now is to reassess this framework. He probably wants a more precise, market-signal based monitoring system rather than relying solely on macro models. This matches his pragmatic, market-friendly style. He believes central banks should listen more to the market. So under this group's push, we might see more dynamic adjustments to the QT taper in the future, which is good for stabilizing banking and money market expectations.

Jack Farley: Interesting. Um, okay. Another one of the We're just going through the list of t There's a lot of task forces. There's a there's a data task force as well.

杰克·法利: 顺便说一下，各位，如果有美联储的人正在收听本节目，我真的很想加入特别工作组。那肯定会非常棒。

Jack Farley: By the way, guys, I just want to know I would love to be on a task force if anyone is listening. That'd be great.

Joseph Wang: Yeah, there's you can be in any of these, I imagine. Yeah. Um, all right. So, this data task force is also attracting a lot of attention. Because we've all seen the challenges the Fed faces with data usage, like big revisions. How are you thinking about what data compositions they're going to start to use?

Joseph Wang: I think that's a legitimate concern. We have had a lot of big revisions to jobs, non-farm payrolls. This was a headache during the GFC when people were concerned that official data wasn't accurately measuring inflation because the collection methods were lagging. So you had a huge effort to collect data through non-public means, like the Billion Prices Project, using online retail data to track price changes. So, the public sector could benefit from some of that technology. The risk of course is that you know we do all this and we end up realizing actually the best way of measuring inflation is trending PCE guys. So so that that is always

Jack Farley: funny how that works. Yeah

Joseph Wang: that that is always the risk of doing that. And also remember not too long ago there was a labor market report that was not good and that kind of got someone fired, right? So again there is there is a risk of more of a uh politicization of our data and that's very concerning. No matter what your political views are. But overall, if we can optimize data analysis by using better modern tools like AI, that's a great thing. We do have better tools today.

Jack Farley: Yeah. I feel like one of the valid criticisms that people have had of the Fed is that they're always behind the curve and that's sort of fundamentally baked into it because of the data points that they follow or often some of the more lagging metrics, right? Like if you're there's always, you know, those that don't track the economic data closely, like you always have leading metrics, coincident, and then lagging data points. And for the most part, the Fed really focuses on the most lagging of data. Like by the time that d bad data starts to show up in in labor data, you know, things have already been falling apart for quite a while. Um, if they start to move towards focusing on more leading data, do you think that can make them even like too too reactive or too ahead of the curve where obviously it's going to be a bit noisier too if you go towards entirely leading data? like it feels like that could also come forth with its own issues on the other side of the spectrum.

Joseph Wang: No, I think the Fed is is in a difficult position when it comes to that. Let's say they have to act proactively, right? To avert a crisis and they do that, the crisis doesn't materialize and then you know they don't get any credit because it never materializes, right? So, uh it's it's always difficult. You will always have people who are going to yell at you and accuse you of being too late or too early.

Jack Farley: Yeah, fair enough. Um, one of the other ones is around productivity and jobs and the AI revolution that's occurring right now and um, as you mentioned earlier, Wars talked plenty about the emerging productivity boom from AI before his nomination and confirmation and seems like it's going to be top of mind for them. how are you thinking about that one?

Joseph Wang: That was actually so that doesn't have I mean okay like like you mentioned the argument is that we could cut rates because we have a productivity boom. Maybe that's what we discover but so far that you can't see that in the data. So the most recent productivity data is just not that special. So it is a fascinating topic. If you look at historic productivity booms, like agricultural mechanization, it had massive disruptions to the labor market. I like to use the analogy of the late 19th century: farm output multiplied, but it did not make farmers rich. In fact, it was ruinous. Because when everyone could produce so much, prices went down. So even though we had a productivity boom, it led to a long agricultural depression and forced millions of workers to migrate to cities. So even if AI boosts productivity, it doesn't mean it translates into immediate monetary gains or employment. In fact, many industries might see compressed margins due to competition, and people who lose their jobs will have to find new ones. So this task force on productivity and jobs is worthy because looking at the past, technology shifts are disruptive.

Jack Farley: Mhm. Well said. Okay, we're at the last one, which is all about inflation frameworks, which we've we've sort of mentioned already about how there's just all these different ways to measure inflation. And of course, trend bean inflation is is Wars' favorite. uh just also happens to be one of the lowest. So do you think there's a better way for them to think about that and react to in the context of these energy supply shocks which are just exceptionally difficult for central banks to react to? I mean, you've seen the ECB hiked last week even though you can make the argument it's a negative growth shock for Europe especially.

Joseph Wang: Well, I think there's two points here. One is that whereas when you are Fed chair, you have to tell everyone that you know inflation is largely driven by policy that tells people that you have power to meet your 2% inflation target. That's just obviously not true. Like inflation is very complicated, involving global supply chains, geopolitics, fiscal policy, commodity prices. Fed policy only affects demand. If you want to manage inflation effectively, it has to be a concerted effort across the government. For example, using SPR releases, fuel tax holidays, working together. And secondly, on the inflation target itself, having a point estimate like 2% is hard to hit anyway. Having a range target, like 1.5% to 2.5%, makes a lot of sense. It gives you wiggle room, though obviously it might bias inflation slightly higher. But that's a trade-off that opens up the possibility of modifying the framework. So when I hear a task force on this inflation framework, that's my sense because seriously having a point estimate, it's hard to hit to begin with anyway.

Jack Farley: it's never going to be 2% exactly. So, giving yourself a little bit of wiggle room, it makes sense. and and obviously it's going to bias inflation higher.

Jack Farley: All right. So, um just to wrap you up here, zooming out on on the market's reaction to Wars in day one, we saw US equity sold off, the dollar rallied, bonds sold off two-year especially um gold sold off pretty significantly, precious metals overall a pretty hawkish reaction function. But just generally how did this first day played out for for Kevin Wars versus maybe what you expected would happen?

Joseph Wang: Yeah, I expected Kevin Walsh to be the Kevin begging for the job. He came out and he was like the Kevin you always knew was there.

Jack Farley: Yeah.

Joseph Wang: So I think it was a pretty hawkish. I think that it was the hawkish reaction is is in line with the market reaction is in line with the hawkish Fed. Everything is consistent. Now looking at the broader risk market though it's very obvious to me that we are at a point where there is a lot of speculation. Once the Fed focuses on real tightening, these high valuation assets might face liquidity tests. I look at SpaceX and others, valuation has gone to the moon, but lockups unlocking will bring selling. We might see a sustained and meaningful decline in risk assets. Again, I could be totally wrong, as I got the rally after the Iran war wrong, but I look at what's happening and it looks concerning to me.

Jack Farley: Awesome. Well, I appreciate the transparency, the the perspective on the outlook and um yeah, as always, great to have you on during these major Fed days, Joseph. Uh so, thanks again for joining.

Joseph Wang: Thanks so much for having me.