Disappearance of Forward Guidance? Former Federal Reserve Vice Chairman: "The Walsh Federal Reserve" May Have Adjustments in Three Major Areas

Rich Clarida, PIMCO's global economic advisor and former Vice Chairman of the Federal Reserve from 2018 to 2022, believes that under the leadership of Kevin Warsh, the chairman nominee by President Trump, the Federal Reserve will become the "Warsh Federal Reserve," which will see significant adjustments in its policy framework, involving core areas such as forward guidance, balance sheet management, and credit allocation.

Clarida recently stated to the media that Warsh's views on the U.S. economy align with the Federal Reserve's stance from last December, and he may support at least two rate cuts of 25 basis points each, bringing the federal funds rate down to the range of 3%-3.25%. He pointed out that Warsh has recently criticized the Federal Reserve for being "too lagging" and for the slow pace of rate cuts.

Before serving at the Federal Reserve, Clarida was a global strategic advisor at PIMCO from 2006 to 2018. Prior to joining PIMCO in 2006, he served as the Assistant Secretary for Economic Policy at the U.S. Treasury and was the chief economic advisor to two U.S. Treasury Secretaries. He believes it is reasonable for the Federal Reserve and the Treasury to discuss balancing policy objectives. Warsh has previously proposed establishing a new "Treasury-Federal Reserve Agreement" to provide a framework for the two departments to collaboratively reduce the balance sheet.

Clarida believes that investors may notice that the most significant change in the "Warsh Federal Reserve" compared to its predecessor will be in communication policy. Clarida stated that it is possible for monetary policy to operate without forward guidance, and the Federal Reserve under Warsh may significantly reduce detailed guidance on future interest rate paths.

Three Major Directions for Policy Adjustment

Clarida expects the Federal Reserve to adjust its policy framework based on Warsh's previous criticisms. The three potential areas for adjustment he listed include: forward guidance, balance sheet management, and credit allocation related to mortgages.

According to Clarida's writings, Warsh has extensively discussed Federal Reserve policy over the past 15 years and expressed concerns about the size and composition of the Federal Reserve's balance sheet. Warsh has also questioned the central bank's reliance on forward guidance—arguing that it is excessive and sends confusing signals about future monetary policy—and the Federal Reserve's failure to anchor policy formulation and communication to a policy rule that reduces discretionary power at successive meetings.

Recently, Warsh has advocated for establishing a new "Treasury-Federal Reserve Agreement," which, based on specific details, could allow the Federal Reserve to collaborate with the Treasury and mortgage agencies Fannie Mae and Freddie Mac to reduce the size of the balance sheet.

This proposal is noteworthy because the Federal Reserve is currently expanding its balance sheet again by purchasing short-term government bonds through reserve management after ending its quantitative tightening program last December. Under Warsh's proposal, the new framework may also include gradually shortening the duration of the balance sheet to well below current levels, returning to practices seen before the global financial crisis.

Rate Cut Expectations and Inflation Considerations

Regarding interest rate policy, Clarida pointed out that Warsh has recently criticized the Federal Reserve for being "too lagging" and for the slow pace of rate cuts, so he is likely to support at least two rate cuts of 25 basis points each as indicated in the Federal Reserve's economic projections (the "dot plot") for December 2025. These rate cuts have largely been priced in by the market and will bring the policy rate, i.e., the federal funds rate, down to the range of 3%-3.25% Clarida believes that under PIMCO's baseline expected scenario, Waller will be able to secure the necessary support of at least 7 votes from the 12-member Federal Open Market Committee (FOMC) to implement two rate cuts of 25 basis points this year, and there may even be a third cut, bringing the target range for the federal funds rate down to 2.75%-3%, which is the current median estimate of the neutral rate by the FOMC.

However, after the aforementioned two to three rate cuts, Clarida believes Waller may become more cautious, depending on the inflation outlook.

He pointed out that, according to Waller's understanding, long-term bond and mortgage yields are influenced not only by the Federal Reserve's policy rate but also by expected inflation. If the indicators of inflation expectations are significantly higher than current levels, he may be hesitant about further rate cuts. Currently, long-term inflation expectations remain aligned with the Federal Reserve's 2% inflation target.

Significant Shift in Communication Policy Expected

Investors may notice that the biggest difference between the "Waller Federal Reserve" and the previous three Federal Reserve Chairs—Powell, Yellen, and Bernanke—lies in the Fed's communication policy.

Clarida noted that based on Waller's writings after leaving the Federal Reserve, he may significantly reduce detailed forward guidance on the future path of interest rates, especially during "normal" times like the current one when rates have not reached the zero lower bound.

Waller can cite precedents: the eight years under Volcker and the first 17 years under Greenspan successfully led the Fed to achieve price stability and support strong growth, while providing almost no forward guidance on the future path of policy rates in today's sense. However, since then, financial markets and Federal Reserve observers have become quite accustomed—critics would say reliant—on the Fed's "open mouth operations," and the transition to a new communication mechanism may be quite bumpy.

Clarida emphasized that Waller needs to collaborate with the Federal Reserve's committee to advance reforms. He believes there is upside potential for the U.S. economy this year, pointing out that "the tech capital spending boom is real," and mentioning favorable factors such as tax cuts and foreign investment in plant and equipment