- Federal Reserve (Fed) Chairman Kevin Warsh has officially appointed Daniel Covitz, Deputy Director of the Research and Statistics Department, and Eric Engstrom, Deputy Director of the Monetary Affairs Department, as his staff advisors. This move marks a significant personnel reshuffle within the core advisory team of the Fed Chairman.
- The two appointed senior Fed economists recently published critical research on forward guidance tools, quantitatively assessing the anchoring effect of the Summary of Economic Projections (SEP) on private sector expectations. They also explored why U.S. Treasury yields remained high despite the Fed's consecutive cuts in short-term policy rates in 2024 and 2025.
- Warsh also hired two external advisors on a contractual basis, Paul Winfree, a former Heritage Foundation researcher, and Daniel Heil from the Hoover Institution, to assist with the transition. He established five special task forces to focus on reviewing the Fed's daily operations, policy transmission mechanisms, and various dimensions of the overall macroeconomy.
Re-evaluation of the Marginal Effectiveness of Forward Guidance Tools
According to Engstrom's latest analysis, the quarterly released Summary of Economic Projections initially improved market forecast quality to some extent. However, over time, this mechanism has gradually evolved into a rigid market expectation anchor. This anchoring effect has slowed the speed at which private sector analysts adjust macroeconomic expectations based on the latest high-frequency economic data. Warsh has previously criticized tools like the dot plot, arguing that the market tends to interpret these forecasts as rigid policy commitments by decision-makers, significantly limiting policymakers' flexibility in times of dramatic macroeconomic changes.
The Mystery of Diverging Long-term U.S. Treasury Yields and Term Premium
The latest paper co-authored by Covitz and Engstrom critically analyzes the abnormal behavior of the U.S. Treasury yield curve during the monetary easing cycle of 2024 to 2025. The research indicates that despite the Fed lowering short-term benchmark rates during this period, concerns about the monetization of long-term fiscal deficits and the rise of the structural inflation anchor have kept the term premium on long-term Treasuries not only from narrowing but showing strong resilience at high levels. If this research conclusion is adopted by the new Fed decision-makers, the pricing of future interest rate policy paths may need to reassess the actual levels of potential output and the neutral rate.
Policy Flexibility and Future Dot Plot Reform Path
This latest research direction by the internal advisory team aligns closely with Warsh's policy proposals to reshape the Fed's communication mechanism. Sources close to the Wall Street Journal reveal that the five newly established task forces will focus on evaluating the negative spillover effects of the current monetary policy framework. If the task force's evaluation confirms that the dot plot distorts market pricing, the Fed may gradually downplay or modify the format of the Summary of Economic Projections. Once this marginal policy change is established, it will directly lead to a structural revision of the pricing models for the Fed's future interest rate path in the swap market, and the central volatility of the market may also rise accordingly.
