Wattch hearing debut could face plenty of “cross-examination”: inflation, reaction function, interest rates, independence, and more

Source: Jin10 Data

On July 2, Federal Reserve Chair Wosch publicly said that he would not provide forward guidance, and then he added: “I can update one thing: we will meet in four weeks.” When talking about what will be discussed at that time, he also said: “I hope we can have a terrific ‘family argument’… When we walk into that room and close the door, we will have a full-on debate, but beyond that, I cannot provide any more information.”

This style of remarks will serve as the backdrop for his congressional hearing this week. Under legal requirements, the Fed Chair must testify before Congress twice a year. This week, Wosch will appear in sequence before the House Financial Services Committee and the Senate Banking Committee, at 10:00 p.m. Tuesday and 10:00 p.m. Wednesday Beijing time, respectively.

Lawmakers are expected to keep pressing on the economy, inflation, and the outlook for interest rates, but based on Wosch’s recent public comments, it will be difficult for them to get clear answers. Even though he reiterated the Federal Reserve’s commitment to bringing down inflation at a symposium in Portugal, he still refused to provide specifics about the current state of the economy or the path of interest rates.

The Federal Reserve submitted its semiannual monetary policy report to Congress last Friday in advance. The report states that, with inflation still too high, the Fed “will achieve price stability,” which is also the core policy messaging the Fed released to lawmakers before Wosch first testified before Congress.

Since the beginning of this year, U.S. Treasury yields have continued to rise, and the market has already priced in expectations for higher interest rates. The report also notes that, as inflation rises, the level of the federal funds rate corresponding to a quantitative policy rule used by the Fed is above the current target range of 3.5% to 3.75%.

However, the report also explicitly warns against interpreting this rule mechanically. “However, the prescriptions shown here ignore a key fact: if the policy interest rate follows a path specified by the rule, the evolution of the economy will be different; therefore, these prescriptions should be interpreted with caution,” the report said.

On Tuesday, the U.S. will also release the latest inflation data, which means that on the day Wosch testifies before the House, he may face follow-up questions about CPI. Market expectations are that, affected by the pullback in oil prices, June’s CPI year-over-year increase will be 3.8%, lower than May’s 4.2%; the core CPI year-over-year rate excluding food and energy is expected to edge down from 2.9% to 2.8%.

Even if the data are released that day, however, judging from Wosch’s recent communication style, he will likely still avoid giving a clear assessment of the data.

Interest-rate divergence and the “reaction function” debate

The June policy meeting minutes show that most Fed officials believe there are two possible paths for interest rates this year, with the dividing line being whether inflation cools. If inflation eases, rates can be maintained at current levels, or even cut in the future; if inflation proves stubborn, further rate hikes may be needed.

The minutes also present a more binding scenario: if demand related to artificial intelligence remains strong, the conflict in the Middle East continues, or the impact of tariffs continues to feed through, and inflation stays high while the labor market remains stable, then nearly all officials believe it will be necessary to “tighten policy to some extent,” meaning rate hikes.

But to the outside world, the real uncertainty is not only whether rates could rise or fall—it is also how Wosch himself will react to changes in the economy. What people are watching is the Fed Chair’s “reaction function,” meaning how the central bank adjusts policy when economic conditions deviate from expectations, rather than a pre-committed interest-rate path.

Andrew Sacher of Bloomberg Economics makes a distinction here: “Forward guidance tells the market what route the central bank believes it will take. The reaction function tells the market how the central bank will respond to unexpected situations without providing a projected route.”

Richard Berner, a professor at New York University, previously worked on the Fed research team in the 1970s. He said: “Good communication conveys the Fed’s reaction function—the relationship between economic conditions and the policy interest-rate path. And that’s truly indispensable.” He also emphasized at the same time that “this is different from forward guidance.”

The debate on this issue has moved beyond the market and into the Fed itself. Last week, Fed Governor Waller, in a speech in Rome, specifically distinguished between providing forward guidance and explaining how policy responds in different economic environments. He said that the latter can reduce uncertainty faced by markets and households: “This will make everyone’s lives better.”

Wosch himself, however, has clearly focused on compressing forward-looking signals. On July 1, during a discussion in Portugal with other central bank heads, Wosch also defended his communications approach by citing the performance of the bond market. He said: “Volatility hasn’t risen—it’s declined.” He then added: “So when I hear these statements, it’s as if people don’t understand. I think they actually understand very well.”

Not all observers accept this assessment. Michael Feroli, JPMorgan Chase’s chief U.S. economist, believes that if Wosch continues to stay silent, he may cede the initiative in Fed communication to other policymakers. Feroli said: “He hasn’t yet shown that he has any control over the current economic situation. We can only rely on other Fed officials to understand how they interpret the economy.”

The Fed spokesperson declined to comment.

What other questions will Wosch face?

Beyond inflation and interest rates, Wosch at the hearing may also be asked about central bank independence. Last week, when asked whether the Fed would take the necessary measures to control inflation regardless of whether Trump prefers low interest rates, Wosch replied: “We have long been an independent central bank, and people won’t see any changes in that regard.”

Artificial intelligence will also be one of the topics lawmakers are likely to press on. Last week, when asked whether AI would exacerbate inflation, Wosch did not provide a clear judgment. He said that he is already seeing the impact of AI on the demand side of the economy, and that he “believes we will also see its impact on the supply side at some point.”

When he took office as Fed Chair, Wosch said that AI could increase productivity and lower inflation, thereby creating conditions for rate cuts. Wosch has also appointed five special working groups to study, respectively, the Fed’s public communication, balance sheet policy, the quality of existing data sources, how the central bank views inflation, and how AI will affect productivity and employment. The semiannual monetary policy report points out that these areas could in the future affect how policy is implemented.

Wosch’s communication strategy is also reflected in institutional arrangements. In June, as usual, policymakers submitted quarterly economic forecasts and interest-rate forecasts to be used to form the so-called “dot plot,” and Wosch did not participate. The length of the post-meeting statement was noticeably shorter, and the meeting minutes released three weeks later were also more condensed. Wosch’s effort to shorten the post-meeting statement received support from some participants; some officials welcomed a re-examination of the Fed’s communication practices. Against the backdrop of rising economic uncertainty, other officials have recently also mentioned that it is necessary to reduce reliance on forward guidance for investors.

But this support is not without conditions. If the new communication approach makes it harder for the outside world to understand how the Fed judges the economy and adjusts policy accordingly, support may weaken. Waller said in Rome that maintaining clarity in the reaction function is one of the “most critical lessons” gained in central bank operations over the past three decades.

This controversy has also led many veteran observers to think back to earlier periods of the Fed. Lou Crandall, chief economist at Northern Trust, recalled that when he began his career in the 1980s, the Fed would not even publicly convey interest-rate decisions—“it was an utterly absurd mess.”

Greenspan gradually expanded communication with the market, but even then his wording was often ambiguous to the point where investors would place bets based on extremely subtle cues—down to the thickness of the briefcase he carried when attending policy meetings. Crandall said: “There are many people in the market who have their own unique views about the Fed and make a big deal out of them. When the Fed doesn’t try to outline its views—not that absolute certainty is needed, but a certain degree of clarity—these theories will run rampant.”

Don Kohn, the former Vice Chair of the Fed, believes it is understandable for a new chair to spend time sorting out his thinking, but this situation will not last indefinitely. He said:

“At some point, he will have to provide more detailed economic views—to tell us what he thinks and how that aligns with the committee. My guess is that this situation won’t continue forever.”