Has the Fed left the market to tighten financial conditions on its behalf? Analysis suggests that Waller's downplaying of forward guidance may weaken the precision of policy.

Federal Reserve Chair Waller has continuously pushed for reforms in the communication of monetary policy since assuming office, hoping to reduce the impact of forward guidance on the markets, allowing financial markets to price themselves more based on economic data, and assisting in achieving inflation suppression goals through changes in market interest rates. However, several economists, former Fed officials, and market strategists believe that while this approach is theoretically viable, it is a more "blunt" policy tool compared to directly adjusting the federal funds rate, which could increase market volatility and weaken the Fed's ability to finely tune the financial environment. Market rates replacing policy rates? Analysts say the Fed may lose its precise control ability. Traditionally, the Fed primarily influences the financial environment by adjusting the federal funds rate, subsequently transmitting to loan rates, bond yields, and financing costs, to achieve precise adjustments in economic activity and inflation. Mark Cabana, a former New York Fed official and current head of interest rate strategy at Bank of America, stated that the real issue lies in whether the Fed wants to continue to control the financial environment. If we are just relying on long-term Treasury yields to fluctuate on their own, the Fed has effectively lost control and will struggle to determine how much rates should rise or fall. Former Fed board member Jeremy Stein pointed out back in 2013 that the importance of the policy rate is that it can impact the entire financial system, penetrating into all corners. Waller emphasized that the market has already accomplished some of the tightening work for the Fed. At the end of Julys policy meeting, the Fed maintained the federal funds rate in the 3.5% to 3.75% range for the fifth consecutive time. During the post-meeting press conference, Waller repeatedly emphasized that in the 42 days since he took office, while the Fed had not altered the policy rate, the market had undergone significant changes. He said, In a sense, we have not taken action for 42 days, but the market has already done a lot. Waller specifically noted that U.S. Treasury yields have been rising steadily recently, suggesting that the financial market itself has tightened the financing environment, thus there is no urgency to raise rates. According to media reports citing informed sources, although the previous communication method once triggered severe fluctuations in the bond market, Waller still plans to adhere to the current strategy of reducing forward guidance. At the same time, he acknowledged that he has also faced shortcomings since his appointment, including not sufficiently reinforcing the core message of the Fed's commitment to maintaining price stability. However, if inflation data continues to remain high in the coming weeks, he is willing to support a rate rise in September. The lack of forward guidance may amplify market volatility. However, several analysts warned that if the market is left to bear more of the tightening function, it could lead to excessive volatility in yields. After Wallers press conference, the yield on the 30-year U.S. Treasury bond surged to its highest level since 2007, directly reflecting the market's reassessment of the policy path. George Catrambone, head of fixed income at DWS Americas, cautioned, Be careful what you wish for. If long-term interest rates rise unchecked, it could have a much greater impact on the real estate market and corporate financing than originally intended by the policy. Bloomberg strategist Michael Ball also pointed out that Waller's reforms could further increase the steepness of the yield curve, with short-term rates relying more on economic data, while long-term yields will increasingly incorporate policy credibility and premium for Treasury supply. Another risk lies in the possibility that if the market believes the Fed will not take true measures, market rates may instead fall back, diverging from the financial environment needed to control inflation, ultimately forcing the Fed to adopt more aggressive policies. The market has lowered the expectation of a rate hike in September. Former Fed Vice Chair Don Kohn stated that if the market believes that demand should be curbed through rate hikes, but the Fed delays action and merely relies on the market to tighten the financial environment on its own, the market may ultimately retract the previously formed tightening expectations. This change has already begun to manifest. Before Wallers press conference, the market expected the probability of a September rate hike to be around 70%; currently, that probability has fallen to below 60%. Waller believes that reducing forward guidance can compel investors to focus more on the economic data itself rather than the speeches of Fed officials, thereby forming more genuine market price signals and providing a basis for policy-making. However, unlike previous chairs, Waller not only refuses to disclose future policy paths but also avoids publicly discussing how he interprets economic data and how he would respond to different economic scenarios. U.S. Treasury Secretary Janet Yellen expressed support for this. She believes that the U.S. market is going through a "detox period" in shedding its long-standing dependence on the Feds forward guidance and large-scale bond purchasing policies, and that in the future, the market should price based more on fundamentals rather than the speeches of Fed officials. An increasing number of officials support taking direct action. Although Waller insists on the new communication framework, more and more Fed officials are beginning to publicly express their support for rate hikes. At the July FOMC meeting, Minneapolis Fed President Neel Kashkari, Dallas Fed President Lorie Logan, and Cleveland Fed President Loretta Mester all voted in favor of a 25 basis point rate increase; St. Louis Fed President James Bullard, who does not have voting rights this year, also publicly expressed support for tightening policy. Bullard stated in an interview that last week's substantial rise in yields reminded the Fed that it must earn the market's trust every day through effective communication and by taking action when necessary. Brij Khurana, a fund manager at Wellington Management, said that the greatest value of forward guidance lies in the fact that if the market believes the Fed will take action in the future, the Fed can actually remain stationary for a while; however, if this communication mechanism is removed, the Fed may have to rely on more actual rate hikes in the future to achieve the same economic effects. Kashkari holds a similar view. He stated that if inflation remains persistently high, it is better to start taking a series of gradual, small rate hikes now rather than being forced to make significant hikes later. Market participants generally believe that Wallers speech at the Jackson Hole Global Central Bank Symposium at the end of August will be an important window to observe whether there will be further adjustments to his monetary policy framework. Alex Payne, a senior portfolio manager at Vanguard Group, expressed expectations that Waller will further emphasize market focus on restoring inflation to the 2% target, thus re-anchoring market expectations.