Fed's Waller defends forward guidance as 9 officials eye rate hike

Waller's defense of forward guidance at a Rome forum exposed a deepening rift with Chair Warsh over how the Fed should communicate with markets.

Federal Reserve Governor Christopher Waller said forward guidance remains a "valuable tool" for speeding monetary policy transmission, pushing back against Chair Kevin Warsh's push to minimize the central bank's communication about future rate moves.

"I continue to believe that forward guidance can be a valuable tool that has, at times, significantly strengthened policymaking and will continue to be useful," Waller said Monday at a Bank of Italy conference in Rome. "But forward guidance is more art than science, and there have been times when it has hindered, rather than helped, policymaking."

Waller pointed to the fall of 2021 as evidence that forward guidance works when used flexibly. The FOMC signaled it would soon raise rates to combat rising inflation, and two-year Treasury yields rose nearly 200 basis points from September 2021 to mid-February 2022 — before the Fed delivered its first hike in March 2022. That effectively shaved about six months off the typical 12- to 24-month lag for monetary policy transmission, he said.

The remarks put Waller at odds with Warsh, who has removed forward guidance from the FOMC's post-meeting statement and told a European Central Bank forum last week that the practice is "not suitable" for the current environment. Warsh has argued that forward guidance makes the Fed less nimble and that markets function best when left to interpret economic data on their own.

The 2021 lesson: When guidance backfired

Waller acknowledged that forward guidance can also misfire. He cited the Fed's September 2020 commitment to hold rates near zero until inflation "moderately exceeded 2% for some time" — language that remained unchanged through 2021 even as inflation surged and unemployment fell rapidly.

"This guidance didn't change over the course of 2021 as inflation was rising quickly above 2% and unemployment was rapidly falling, leaving the public to wonder what 'for some time' meant," Waller said. "In the end, this restrictive guidance tied the hands of the FOMC in 2021 and unnecessarily delayed rate increases."

The Fed did not deliver its first rate hike until March 2022, by which time consumer price inflation had already exceeded 7%.

A distinction between guidance and reaction function

Waller drew a sharp line between forward guidance — a commitment to a specific policy path — and a central bank's "reaction function," which describes how policymakers will respond to incoming data. A well-defined reaction function reduces the need for frequent communication, he said.

"As long as your reaction function is well defined, well understood, you don't necessarily have to talk that much," Waller said. "But if your reaction function is not well defined and markets don't understand it, then you do need to speak."

The Fed is expected to announce members of a communications policy task force this month, one of five groups Warsh has convened to recommend policy reforms by year-end. The task force will examine how the Fed communicates its policy intentions to markets and the public.

Policy outlook shifts as labor market stabilizes

Waller said the policy environment is undergoing a critical shift. After supporting rate cuts in 2025 to boost employment, he now sees the labor market stabilizing, allowing the Fed to refocus on inflation, which has risen to its highest level since 2023.

"The risks have completely flipped," Waller said. "That changes how you think about the direction of policy."

The Fed held rates unchanged at its last meeting, but the dot plot showed 9 of 18 officials projecting at least one rate increase this year. The split between Waller and Warsh on communication strategy adds another layer of uncertainty for markets trying to parse the Fed's next move.

This article is for informational purposes only and does not constitute investment advice.