Wall Street adapts to new era of Federal Reserve communications

F/m Investments’ Washington, D.C., office is just a short drive from the Federal Reserve‘s headquarters. But under the central bank’s new leadership, CEO Alexander Morris has found the distance feeling far greater.

Fed Chairman Kevin Warsh embarked on an overhaul of the central bank’s forward-looking communication since taking the post in May. That move sounded the alarm for market participants like Morris, whose investing theses rely in part on predicting what the Fed will do with interest rates.

“We’ve made a pretty good business out of decoding Fedspeak,” said Morris, referring to the jargon-heavy communication preferred by central bank leaders. “And he just said he was going to go quiet on us.”

This week, Morris’ firm, which manages exchange-traded funds tied to inflation and U.S. Treasurys, released “WarshGPT.” It’s an artificial intelligence-powered tool that parses nearly 1,800 documents and transcripts from Warsh, with the goal of helping users understand how he may analyze issues related to the economy or monetary policy.

F/m Investments is one of many financial institutions readying for an era with less public forecasting from Warsh’s Fed. In some cases, they’re turning to AI models to gain an edge in investing.

“Whether the Fed is providing a lot of information or a little information, investors have to understand what the Fed is likely to do in the future,” said Gary Richardson, a former historian at the central bank who’s now a University of California, Irvine, economics professor. “With limited information, people are going to try to do anything they can to figure out what the Fed is thinking.”

Investors and Fed watchers have wondered if former Chairman Alan Greenspan‘s communication style can serve as a baseline for what to expect under Warsh.

In that era, Richardson said people joked that Greenspan simply saying “good evening” could cause a market decline. Financial media tracked a so-called briefcase indicator, which operated on the theory that Greenspan carrying a bulkier bag meant he accumulated evidence for why borrowing costs should be altered. 

Already, Warsh has made expectations clear for a shift in how the Fed publicizes information. One of his task forces aimed at reshaping the Fed’s operations is focused on how the central bank communicates.

June’s Federal Reserve meeting statement — the first such release under Warsh — contained around 130 words, down from figures above 300 words seen in prior publications, a CNBC analysis found. Warsh, who acknowledged the statement was “shorter” and “simpler,” said it purposefully excluded forward guidance.

In his first post-decision press conference as chairman, Warsh allocated 5% of sentences to policy-relevant topics, according to UBS. That number came in at 27% for an average meeting under predecessor Jerome Powell, the bank said.

F/m Investments’ WarshGPT chatbot cost less than $1,000 to build with Anthropic‘s Claude model, despite the name being a riff on rival OpenAI‘s ChatGPT. It took roughly two weeks to create from inception to release, a timeframe that included pre-rollout testing by a group that included Fed alumni and newsletter writers.

In addition to Warsh’s communications, the product also taps into economic and political history to ensure its responses have context. But F/m set limits to what WarshGPT can do: The bot doesn’t talk as Warsh and will not offer offer forward statements or forecasts.

F/m isn’t the only large firm reconsidering its strategies and tools for understanding a Warsh-led central bank. 

UBS runs an interactive dashboard for clients to track the Fed’s policy tone. It allows users to have an unbiased assessment of Warsh’s commentary during meetings, according to Elena Amoruso, a strategist at the Swiss bank.

Following Warsh’s debut policy meeting as chief last month, Amoruso told clients that Warsh’s policy-relevant comments were “overwhelmingly hawkish.” The central bank leader’s stance was driven by his views on the labor market and growth, she said, in addition to the state of inflation.

“Arguably, this is the most high-value data set … in terms of how much one word can move dollars,” Amoruso told CNBC.

At JPMorgan Asset Management, chief global strategist David Kelly has some backup plans if the Fed stops putting out key releases. If the central bank does away with the “dot plot,” for instance, Kelly said his team will more closely mull over speeches by members of the Federal Open Market Committee — the group tasked with setting interest rates — to get a sense of how they would next vote.

To be sure, Kelly said major changes to Fed communication would likely take several months to announce and implement. He said the final decisions may not be as drastic as some expect.

“Just like the Federal Reserve says it can be patient in adjusting interest rates to the economy, we can be patient in adjusting our resources,” Kelly said.

Still, investors anticipate having less forward guidance from the Fed could result in bigger market swings after policy decisions or members’ public appearances. Some traders see a chance to rake in larger returns in this environment.

“If there’s less communication about the reaction function, I actually think that’s a negative for the economy,” said Steve Friedman, a New York Fed alum who’s now senior macroeconomist at MacKay Shields. However, “less clarity about what the Fed may do can actually be a source of alpha for investors if you have a robust framework for thinking about the economy and monetary policy.”

If Warsh dials back public speaking engagements, Friedman said he would more closely monitor speeches from Fed Governor Christopher Waller. Friedman described Waller as a “bellwether” for the broader committee.

Waller said this week that the Fed shouldn’t be focused on “fighting the last war” with inflation, but that interest rate hikes could still be on the table. 

Retail traders may need to further diversify their portfolios to account for added policy uncertainty under Warsh, according to UC-Irvine’s Richardson. Investment firms looking to get ahead, meanwhile, will be spending big to hire Fed alumni who can help make predictions in a lower-transparency environment, Richardson said.

There are already differing expectations forming for how the Fed will proceed with policy in the coming months.

Fed funds futures traders are pricing in an almost 59% likelihood that the central bank increases interest rates in September, according to CME’s FedWatch tool. On the other hand, Kalshi traders think it’s most likely that the Fed will keep rates unchanged at that meeting.

“For ordinary investors, it’s already really hard for them to figure out what’s going on,” Richardson said. “It’s going to become much harder.”