Bank of America economists warn Kevin Warsh’s Fed strategy poses a risk to markets — how to protect your money

 Kevin Warsh has wasted little time reshaping the Federal Reserve since taking over as chair earlier this year.

At his first press conference in June, Warsh made clear that he wanted to pull back from the central bank’s reliance on “forward guidance” — the practice of signaling where interest rates could be headed — arguing that it is not “well suited” to the current economic environment (1). He has also launched a broader review of how the Fed approaches inflation and monetary policy.

That shift was on display again after the Fed’s July meeting, when policymakers voted 9-3 to keep the federal funds rate at 3.50% to 3.75% (2).

While three officials favored a rate hike, Warsh declined to signal what the Fed might do next. He instead pointed to the sharp rise in bond yields since the Fed’s previous meeting and said policymakers would act when necessary.

But Warsh’s reluctance to lay out what comes next has some economists worried that investors aren’t getting enough information to understand how the Fed will respond to changing economic conditions.

Among them are Bank of America economists Aditya Bhave and Mark Cabana.

In a research note provided directly to TheStreet, they argued that the problem isn’t necessarily Warsh’s decision to stop telling markets whether the next Fed meeting could bring a hike, cut or hold (3).

Rather, they’re concerned investors don’t have a clear enough picture of what would cause the Fed to change course in the first place.

Why Bank of America economists say Warsh’s strategy is risky

At the heart of Bank of America’s concern is what economists call the Fed’s “reaction function.” Essentially, it’s how policymakers respond when inflation, employment and other economic indicators change.

Bhave and Cabana argue investors need a better understanding of which inflation measures Warsh is watching, how he defines underlying inflation and how far inflation can stray from the Fed’s 2% target before policymakers feel compelled to act.

Without that framework, investors may demand a greater return for taking on the uncertainty of holding longer-term assets.

The BofA economists argue that the resulting risk premium “works like a tax on the economy,” according to TheStreet (3). Higher Treasury yields can filter through to mortgages and other loans, making it more expensive for consumers and businesses to borrow.

The bond market’s reaction after the July meeting added to those concerns.

Long-term yields climbed even as shorter-term yields fell, with the 30-year Treasury yield crossing 5.2% for the first time since mid-2007. Reuters reported that the move reflected questions about the Fed’s credibility and whether investors believed policymakers were doing enough to contain inflation (4).

That matters because inflation remains above the Fed’s 2% target, leaving policymakers with difficult decisions about how long to keep rates elevated or whether further hikes will ultimately be necessary. The Fed’s preferred path has become harder for investors to predict just as uncertainty around rates, inflation and the economy remains high.

Bank of America isn’t predicting that Warsh’s approach will send the economy into a tailspin. But its warning highlights another risk investors have to contend with: Uncertainty over Fed policy itself can influence markets and borrowing costs even before policymakers change rates.

Protect your portfolio when the Fed is unpredictable

Investors can’t control what Warsh or the Fed does next, but they can control how exposed their portfolios are to any one market outcome.

Diversifying across different types of assets can provide another layer of protection when stocks, interest rates or inflation don’t move as expected.

One asset investors have historically used to diversify beyond stocks and bonds is gold.

According to the World Gold Council, gold tends to behave differently from equities and other risk assets, with its negative correlation to stocks increasing during sharp market selloffs (5).

That doesn’t mean gold will always rise when stocks fall and its price can be volatile, but those different performance patterns can give it a distinct role within a diversified portfolio.

One way to invest in gold that also provides significant tax advantages is to open a gold IRA with the help of Priority Gold.

Gold IRAs allow investors to hold physical gold or gold-related assets within a retirement account, which combines the tax advantages of an IRA with the protective benefits of investing in gold, making it an attractive option for those looking to potentially hedge their retirement funds against economic uncertainty.

To learn more, you can get a free information guide that includes details on how to get up to $10,000 in free silver on qualifying purchases.