Kevin Warsh has been measuring his term as Federal Reserve Chairman by days. As of September 28, he had been in office for 129 days, and the paradigm shift in monetary policy he promised is gradually taking shape. In areas where he has more control and visibility, Warsh has pushed for reforms quickly. However, due to the current state of the US economy and the opinions of his colleagues on the Federal Reserve Board, deeper structural reforms have been hampered. He has reshaped the Fed's external communication model, abandoning the long-used neutral interest rate analysis framework and instead using broad financial conditions as the core of policy judgments. This shift has sparked widespread discussion in global financial markets and foreshadows a potential period of sustained tightening in US monetary policy.

The Federal Reserve is reshaping its external communication mechanisms; the change in form reflects a shift in underlying thinking.

Warsh quickly imprinted his personal mark on the Federal Reserve's external communication system. Some adjustments appear to be merely superficial, such as shortening the press conferences following the Federal Open Market Committee's interest rate decisions and rearranging reporters' seating according to the alphabetical order of news organizations. However, beneath these surface changes lies a profound shift in the logic of monetary policy communication. Warsh's interpretation and communication of monetary policy are significantly different from those of previous Federal Reserve chairs. Despite frequent reforms, one of his core policy objectives—reducing the Fed's balance sheet—remains temporarily stalled, primarily due to persistently high inflation. In addition, Warsh established five special task forces to comprehensively review the Fed's policy implementation. These task forces plan to submit a research report early next year, an arrangement that has also delayed the progress of some of his reform plans. The Fed's unanimous approval of a 25-basis-point rate hike, the first since 2023, addresses external concerns and alleviates market worries about Warsh's inability to operate independently of Trump's policies. Based on Warsh's understanding of the market and the macroeconomy, as long as inflation persists, he is likely to support further rate hikes.

Abandoning the neutral interest rate framework, we will use comprehensive financial conditions as the policy benchmark.

For a long time, successive Federal Reserve chairs have habitually used three labels—accommodative, neutral, and restrictive—to describe the range of the federal funds rate. At a press conference held in the early hours of September 17th Beijing time, when asked where the current interest rate was relative to the neutral rate, Warsh directly rejected the premise of this analytical framework. He stated that the concept of the neutral rate only has academic reference value and cannot be used as the basis for interest rate hike decisions. This statement caused considerable ripples in the global central bank community. Economist Claudia Sahm questioned Warsh's approach, stating that while he defined this rate hike as "withdrawing some accommodative policy," he also rejected the concept of a neutral rate, which defines the degree of accommodativeness. He questioned how the Federal Reserve would determine whether to continue raising rates and when to stop. Back in July, the market criticized Warsh's policy statements as vague and lacking a stable and consistent interest rate pricing logic. Now, a completely new policy assessment paradigm is gradually taking shape. This new paradigm incorporates a large number of financial and market indicators into decision-making considerations. In his speech in Jackson Hole, Wyoming, and his latest press conference, Warsh repeatedly emphasized that "financial conditions" are at the core of policy thinking. He believes that, based on comprehensive market signals, current overall financial conditions have not yet reached a restrictive level. Warsh proposed that indicators such as the level and trend of cross-sector asset prices, the price and trading volume of US Treasury bonds, the dollar exchange rate, credit costs and availability, and the price of a basket of commodities are needed to jointly assess the short-term prospects of the economy and inflation, and to identify risks and uncertainties within the financial cycle. This logic is controversial due to circular reasoning, because the market's expectations of the Fed's policies are themselves an important component of financial conditions, essentially the market transmitting its pre-existing policy signals to the Fed. However, literally, this framework leaves ample room for further interest rate hikes. Currently, the stock market remains resilient, the labor market is strong, various indicators on the credit lending side have not shown the effects of policy constraints, and the economic growth momentum is strong. Market pricing once indicated that the probability of another Fed rate hike in October reached 70%, and the market expected that the Fed might raise rates a maximum of two more times between now and March of next year. Warsh's focus on various market indicators far surpasses that of previous chairs, a style similar to Alan Greenspan, who was known for his in-depth analysis of minute economic signals, from corporate capital expenditure plans to scrap metal prices. In his Jackson Hole speech, Warsh stated that he continuously tracks multiple monetary expansion indicators, including credit spreads, senior credit officials surveys, and credit supply and demand, concluding that the current monetary environment remains relatively loose . The credit market has shown little to no restraining effect from monetary tightening, which explains this year's credit growth. In Warsh's policy framework, the Fed needs to tighten policy when inflation exceeds the target and the private lending system becomes excessively loose . Meanwhile, rising commodity prices are also a cause for concern; the Bloomberg Commodity Index has risen over 30% this year, with diesel prices soaring by 83%.

Reform efforts are diverging, and the balance sheet reduction plan is encountering multiple obstacles.

Not all members of the Federal Open Market Committee (FOMC) have abandoned the neutral interest rate framework in favor of Warsh's assessment system, which centers on financial conditions. Financial conditions have historically been a reference point for Fed officials' policy assessments, but few have elevated them to the level of a core decision-making benchmark. Former Fed Chairman Jerome Powell, while acknowledging the extreme difficulty in calculating the neutral interest rate, still assessed it as being in a "moderately restrictive" range. Currently, only Warsh refuses to provide a forecast for the federal funds rate in the Summary of Economic Projections, also known as the dot plot. Many members still release their own predictions about the economy and interest rates in speeches and interviews, a practice Warsh has abandoned. This divergence also reflects the slow pace of paradigm shifts. The composition of the committee and the current state of the macroeconomy are both limiting the speed at which Warsh's reforms can be implemented. Reducing the balance sheet is Warsh's longest-standing policy objective, and reforms in this area have been the slowest. Since at least 2011, Warsh has advocated that the Fed reverse the continuous expansion of its balance sheet, which currently stands at $6.7 trillion. However, he has yet to finalize a plan for quantitative tightening. Possible paths include directly selling securities or not renewing maturing bonds. In 2011, Warsh left the Federal Reserve Board for the first time due to unease about the continued expansion of the balance sheet, though he stated at the time that he would still vote in favor of expansion out of loyalty to the institution. Now back at the helm of the Fed's policy agenda, Warsh is unable to quickly implement a quantitative tightening plan. The minutes of the July Federal Open Market Committee meeting show that other voting officials did not support a rapid rollout of quantitative tightening, preferring to wait for the five task forces to complete their reports before making a decision. The economic and market environment also increases the difficulty of implementing quantitative tightening. High inflation coupled with soaring oil prices means the committee's primary task is to address price pressures, and it is not appropriate to hastily test the effects of quantitative tightening on the economy. Meanwhile, the 10-year Treasury yield has exceeded 5%, driving up mortgage and consumer credit rates. If the Fed were to initiate quantitative tightening, releasing more Treasury bonds and mortgage-backed securities into the market, the current market environment is clearly unsuitable.

Conclusion

Warsh's paradigm shift at the Federal Reserve, spearheaded in his first 129 days in office, was a paradoxical endeavor. While adjustments to the communication mechanism have been implemented, the core balance sheet reduction reform has encountered significant obstacles. The policy judgment framework has been completely rewritten, placing financial conditions at the forefront, yet a consensus has not yet been reached within the Fed. Currently, with ample credit conditions, soaring commodity prices, and inflation persistently above the 2% target, the likelihood of further Fed rate hikes remains high, according to Warsh's new policy logic. However, internal disagreements within the Fed and the debt pressure from high Treasury yields will constrain the extent of monetary policy tightening. This new monetary policy framework will continue to influence the trajectory of US Treasury bonds, the dollar, and global commodities, and the Fed's subsequent policy decisions will continue to resonate with global capital markets.