Subscribe
Share
Share
Embed
Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays), and a new monthly Q&A format called the Confluence Mailbag.
Welcome to the Confluence Investment Management Asset Allocation Biweekly Report for 07/20/2026. I'm Phil Adler. Financial markets are always trying to anticipate what the Fed's next move may be. Making an accurate prediction may become more challenging under new Federal Reserve Board chairman Kevin Warsh. Confluence Associate Market Strategist and Certified Business Economist Thomas Wash joins us today to discuss Warsh's strategy and how it might impact investors.
Phil Adler:Thomas, Walsh seems intent on making the Fed less transparent. As Walsh sees it, what's the problem?
Thomas Wash:Hi, Phil, and thank you for having me. I think Fed chair Kevin Walsh believes the Federal Reserve has drifted too far from its core mandate, which has severely eroded its credibility with markets. While he points to several drivers of this loss of credibility, such as an overreliance on backward looking data and a perceived risk of politicization. He has particularly been critical of the Fed's communication strategy. In his view, market participants have become over dependent on forward guidance.
Thomas Wash:To address this, he has established a task force to review the central bank's communication framework and determine whether it would be prudent to scale back or maybe even entirely eliminate foreign guidance.
Phil Adler:Well, let's go back a bit. How did the Fed arrive at this point where it became perhaps too transparent?
Thomas Wash:To understand where we are today, it helps to go back to the great financial crisis. You know, historically, the Fed used forward guidance very sparingly to nudge market expectations. However, that changed in 2008 when the Fed came under intense scrutiny and markets were dealing with a high degree of uncertainty. Now during the time, Bernanke's response was to significantly increase transparency. He introduced regular press conferences, initially once a quarter, to clarify policy and guide expectations as the Federal Reserve rolled out extraordinary measures like zero interest rates and quantitative easing.
Thomas Wash:Now this was a major shift, but it gave markets a much clearer sense of the Fed's reaction function during a very uncertain period. And, you know, the change didn't stop just there, it evolved. Under Powell, forward guidance became even more central to the Fed's toolkit. He moved to have press conferences after every meeting, effectively turning communication into a core policy instrument. At the time, the Fed was trying to normalize policy without unselling markets, and Powell leaned heavily on signaling to guide that transition.
Thomas Wash:And that's how he arrived at what Warsh would describe as an overly transparent Fed, one where communication has become just as important as the policy itself.
Phil Adler:Well, we know the Fed was criticized as the nation emerged from the COVID crisis for labeling inflation as transitory. So my question is, how did this transparency policy guide the Fed to erroneously approach the path of inflation?
Thomas Wash:Long story short, I think the Fed's biggest mistake wasn't really their their math. It was their messaging. They prioritized transparency during a period of rapid, unprecedented change, hoping to give the markets a reliable roadmap. Instead, they basically created a straightjacket. By doubling down on the transitory narrative, they mortgaged their credibility.
Thomas Wash:When the data flipped, the market basically just stopped listening. I think the Fed's real problem was just bad luck. They were hit by an avalanche of exogenous shocks that just wouldn't stop. Every time they thought they had a grip on the situation, the floor gave way beneath them. Look at the chaos they were juggling all at once during the time.
Thomas Wash:You know, they had surging demand smashed into a shrinking labor force. You had lockdowns flip flop being across the world, idling factories in one hemispheres while grid locking ports in another. And then just to pile on all this absurdity, the dominoes just kept falling. You had a megaship blocking the Suez Canal, you had hackers holding The US pipeline for ransom, and Europe plunging into war, which sent shockwaves through the global food and energy markets. I think the Fed's forward guidance on, you know, saying lower for longer interest rates were intended to soothe market expectation, but it just became a case.
Thomas Wash:They insisted on inflation being transitory right up until the reopening of the economy, and that proved to be completely obsolete.
Phil Adler:And how did the Fed try to make up for this error?
Thomas Wash:I don't think it would be too much to say that they overcorrected. The central bank went from being too slow to being completely reactive. They were aggressively chasing every single new piece of economic data. Whenever it felt like inflation wasn't coming down fast enough, they just cranked up the sides of the interest rate hikes. It started with a standard 25 basis point hike, then they bumped it to 50 basis And before we knew it, they were hitting the economy with massive 75 basis points hikes at consecutive meetings.
Thomas Wash:They moved with such violent speed that they broke things in the broader financial system. The most high profile casualty was Silicon Valley Bank. SVB had loaded up on long term bonds because they took the Fed at its word that interest rates would stay lower for longer. But when the Fed suddenly slammed on the brinks and jacked up rates at lightning speed, the value of those bonds plummeted. That created a massive mismatch on their balance sheet, and, ultimately, it triggered the bank's total collapse.
Phil Adler:So just to emphasize this point you're making, the Fed's policy wasn't necessarily wrong, but it it was simply that the Fed moved too quickly. Quickly.
Thomas Wash:I think that would be even putting it lightly to a degree. I mean, the real issue is that they were desperately trying to make up for lost time. Because they started too late, they overcompensated and went completely overboard. And when you move that fast, it shocks the system. That sudden aggressive pivoting sent shockwaves through the bond market.
Thomas Wash:Investors were suddenly operating in a fog of uncertainty. They weren't even sure if the Fed could successfully bring down inflation to that 2% target. So to protect themselves against this massive uncertainty, investors started demanding a much higher premium for holding longer dated securities.
Phil Adler:Does Walsh have a point here? Has all this led to an erosion of financial market trust in the Fed?
Thomas Wash:I think Warsh actually makes a very compelling case. Think about the chain reaction here. Because the Fed locked itself into maintaining those ultra low rates, while inflation was clearly ramping up, it opened the floodgates for heavy criticism. It made their entire decision making process look flawed. And you can argue this policy failure is exactly what gave teeth to the political attacks against them.
Thomas Wash:When a central bank makes a mistake that big, it invites intense scrutiny. Every single move they make gets put under a microscope. Take 2024 for example. Even though the Fed had been hinting for months that rate cuts were on the table, the market was still caught off guard by the timing and size of the cut in September. And because it happened right ahead of a major election, it fueled speculation about political bias.
Thomas Wash:Fair or not, when you lose Marcus' trust, people start questioning your motives.
Phil Adler:So I guess we can characterize Warsh's desire for less transparency as simply a way to restore trust in the Fed.
Thomas Wash:You know, I think credibility is definitely his ultimate goal, but his immediate motivation is about gaining some flexibility. He wants to give the central bank the room to pivot quickly if economic suddenly changes. Take artificial intelligence for example. Warshard made it clear that he believed AI is a massive, structural disinflationary force that will eventually supercharge productivity. He's also been incredibly honest about the unknowns.
Thomas Wash:He doesn't know when that productivity boom will fully show up, or how much the massive short term infrastructure spending on data centers might actually push up inflation in the meantime. So by scaling back on forward guidance and communicating less, he's trying to protect the Fed from getting cornered. He wants to prevent the markets from overreacting to a single month's data report, giving the Fed the breathing room to manage this wildly tech unpredictable cycle without having to constantly explain away their past promises.
Phil Adler:So what steps do we expect Warsh to take to implement this new communication strategy?
Thomas Wash:Well, we won't know the final shape of any changes until the task force completes its work, which is expected by the end of the year. That said, the direction of travel seems fairly clear. I would expect Walsh to move away from explicit forward guidance toward a more constrained, less prescriptive communication style and practice that likely means fewer signals about the policy path and more emphasis on data dependence. In some ways, it may echo the Greenspan's infamous strategy of mumbling with great incoherence. You know, the idea would be to reduce the market's reliance on Fed signaling and restore a greater role for independent price discovery, only offering clear guidance when it's absolutely necessary.
Phil Adler:What could go wrong?
Thomas Wash:While a worst case scenario isn't our base case, completely pulling forward guidance risks sparking serious bond market volatility. Without that central bank anchor, investors are going to price in a higher uncertainty premium, leading to much sharper, less predictable swings across the yield curve. That said, we think the ultimate goal is less communication with markets, not no communication.
Phil Adler:Thomas, before Warsh was sworn in, financial markets seemed to be anticipating a bias toward lower interest rates. Is this still the case?
Thomas Wash:I would say not anymore. Market confidence in a near term rate cut was heavily tied to The US Iran cease fire. With the collapse of that truth and the resumption of hostilities, the macro outlook has seemed to shift. Fed funds futures and implied policy rates now suggest the market is bracing for a higher for longer pause with some participants even penciling in a potential rate hike before the end of the year.
Phil Adler:Finally, Thomas, if building trust is a key objective for Warsh, how's he doing so far?
Thomas Wash:I think so far, markets have largely given him the benefit of the doubt. There's a willingness to see how this framework evolves before passing judgment. That said, the backdrop is shifting. The escalation in The Middle East introduces a new layer of uncertainty. And in that kind of environment, markets typically place a higher value on clear policy signals.
Thomas Wash:So if volatility picks up, it could raise questions about whether staffing back from forward guidance is the right approach or whether it risks undermining the very trusts Warsh is trying to rebuild.
Phil Adler:Thank you, Thomas. The title of this week's report is In Walsh We Trust, and you can find a link to the written report on the Confluence webpage, confluenceinvestment.com. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. Also, this information does not constitute a solicitation or an offer to buy or sell any security.
Phil Adler:Our audio engineer is Dane Stole. I'm Phil Adler.