The Fed's "Powell era" kicks off: dot plots and forward guidance may fade from view, yield curve reshapes the "AI bull market" plot.

From senior investment managers at Pacific Investment Management Co. (Pimco), the world's largest fixed income market investment giant, it is stated that bond investors will closely watch next week's Federal Reserve monetary policy meeting and all comments made by Kevin Warsh during the press conference, in search for signs of how quickly the new Federal Reserve Chair will make his mark on the central bank. Pimco believes that Warsh will change the way the Fed signals to the market or communicates, but will not keep silent, however, may shift from Powell's era of relatively high transparency, strong forward guidance communication model to a mode with shorter statements, fewer commitments, not relying on dot plots, and emphasizing policy flexibility. Former Vice Chair of the Federal Reserve and Pimco's global economic advisor Richard Clarida said that investors are still trying to determine how Warsh will handle the communication mechanism between the Federal Reserve and the market. If Warsh leads a Fed reform path that firmly repeals the rate dot plots and forward guidance, the direct implication for the financial markets is that investors will no longer be able to overly rely on the Fed's clear language to "stabilize expectations, and must price more through inflation, employment, oil prices, fiscal supply, term premia, and asset-liability path. As the communication mechanism between the Federal Reserve under Warsh's leadership and the market becomes increasingly blurred, there is a high probability that market speculation on the Fed's interest rate hike expectations will increase, and even significantly raise term premia, further strengthening the upward drive of the 10-year Treasury yield, known as the "anchor of global asset pricing. If, as expected, the Federal Reserve under Warsh's leadership does indeed repeal the rate dot plot framework and forward guidance, strengthen the non-farm payrolls to continue increasing the probability of rate hikes, and maintain international oil prices at historically high levels due to ongoing blockades in the Strait of Hormuz, then the important drive behind the global bull market in recent yearsnamely, the AI super bull marketwill undoubtedly face a significant setback, at least in the short term under the pressure of the "global asset pricing anchor," especially those popular AI technology stocks with the highest valuations and largest leverage in the AI computational infrastructure chain will likely be the first to bear the pressure. Pimco decodes the Federal Reserve under Warsh: the fate of the dot plot is suspended, high volatility in stocks and bonds may become the new normal Clarida stated at a Pimco media summit in New York on Thursday, "Looking back to the 1980s, it is understandable that when a new Federal Reserve Chair takes office, there may be a period of weeks or months during which you try to understand the system and the market communication method." "To me, the real question is how much and how Warsh will put his stamp on this communication model and where he will place his emphasis." The new Federal Reserve Chair has lobbied multiple times to succeed Jerome Powell in the position, advocating for a return to a less open and vague monetary policy framework. Warsh stated at an April Senate confirmation hearing, "Unlike many of my current and former Fed colleagues, I do not believe in forward guidance of interest rates based on economic data. Bond investors are weighing the potential changes, including a shorter policy statement by the Federal Open Market Committee (FOMC), the removal of the rate dot plot, and a reduction in the number of press conferences by the Chair. However, if the Fed's economic or rate guidance decreases, predictability is reduced, and internal debates escalate, causing more dissent among Fed policy makers, investors will face higher volatility in the stock and bond markets. Daniel Ivascyn, Chief Investment Officer at Pimco, stated in a recent interview, "From a marginal perspective, a reduced frequency of communication could create greater volatility and uncertainty, which might potentially bring more potential return through an active management approach." "The Federal Reserve under Warsh's leadership will maintain sufficient independence in the areas most relevant to the market, mainly interest rates and balance sheet policy." As shown in the chart above, market predictions for the Fed's monetary policy path display swap curve pricing out more policy tightening than the official dot plot forecasts by the Fed. Note: Predictions are based on overnight index swap rates corresponding to Fed meeting dates. Pricing data from the interest rate swap market shows that traders in the interest rate market are still fully pricing in the Federal Reserve's return to rate hikes in December, aligning closely with bond market traders' hawkish bets. Similarly, the CME's Fed watch tool shows traders are universally betting on a Federal Reserve return to rate hikes in December, with some traders even betting on the Fed starting the rate hike process in October. The short-term rate dot plot was introduced by former Fed Chair Ben Bernanke in 2012 to help guide investors in pricing the Fed's monetary policy path during the ultra-low interest rate era post-financial crisis. Ivascyn stated that forward guidance is crucial when the federal funds rate is at a low level, "So as of now, with the federal funds rate at a relatively high level, from a market perspective, its importance is low." He said, "When we see the dot plots, we will discuss them continuously, which is interesting, but you have to discount these dots significantly. Firstly, they are individual opinions, and there is uncertainty, things are constantly changing." Ivascyn warned that efforts to lower short-term rates in a highly uncertain global economic and inflation outlook may backfire against the Federal Reserve. David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, stated in a media interview on Wednesday, Seeing a 4% headline is not good, and there is clearly no reason to ease policy at the moment, but I think the Fed can stand still. With inflation essentially at the target level of unemployment so far, Warsh may not be inclined to pioneer the rate-cutting process that Trump has been talking about. "People have realized that lowering short-term rates now does not necessarily mean that the very important 5-year or 10-year Treasury yield curve will move in the same direction," Ivascyn added, "If the Fed restarts rate cuts during this uncertain period, the yield curve's further end yields are likely to move in the opposite direction, which we think would be counterproductive. Ivascyn stated that Pimco will wait and observe the important signals for how the Federal Reserve under Warsh's leadership may seek to shrink the central bank's balance sheet; the balance sheet is currently around $6.7 trillion, down from its peak of $9 trillion in 2022. Warsh has repeatedly linked the possibility of rate cuts to reducing the size of the balance sheet. Ivascyn added, The balance sheet is something that we pay considerable attention to, and it may have a major impact on the shape of the yield curve and the performance of bonds with different maturities. It is more important than things related to communication or forward guidance. If the dot plot exits, will the global anchor of pricing dance madly? The Federal Reserve under Warsh's leadership may not necessarily choose to be completely "silent," but may shift from Powell's era of relatively high transparency, strong forward guidance communication model to a mode with shorter statements, fewer commitments, not relying on dot plots, and emphasizing policy flexibility. This most directly implies for the financial markets that investors will no longer be able to overly rely on the Fed's clear language to "stabilize expectations," and must price more through inflation, employment, oil prices, fiscal supply, and even potential term premia and balance sheet path. But the reform agenda that Warsh is planning involves the Fed's inflation analysis framework, balance sheet guidelines, and market communication mechanisms and strategies, and these changes will be both technical and cultural reshaping, not likely to be completed overnight. A Brookings survey also shows that only about 56% of Fed observers believe they have a clear or reasonably clear understanding of the Fed's reaction function, lower than in previous surveys, indicating that even under the current framework, the market's grasp on the Fed's policy reaction function has decreased. For the 10-year Treasury, the "global anchor of pricing," the most important impact is not necessarily a definite rise in short-term policy rates, but the potential increase in long-term rate volatility and term premia. Ivascyn emphasized that if the Fed tries to lower short-term rates in a highly uncertain economic and global inflation period, the 5-year or 10-year Treasury yield curve may not necessarily decline in the same direction, and may even rise due to market concerns about inflation spiraling out of control, policy credibility being compromised, and fiscal supply pressure. In the Warsh era, less communication, fewer forward guidance mechanisms do not mean lower rates, but may instead indicate that the bond market itself is demanding higher risk compensation and term premia. Analysts at Charles Schwab also pointed out that the Iran war, rising oil prices, and inflation expectations have already changed the market's expectations for Fed policy, pushing up Treasury yields. If oil prices stay high or inflation expectations continue to rise, the 10-year Treasury yield may break through the short-term upper limit of 4.5%. Pimco believes that the impact of the balance sheet reduction path on the shape of the yield curve and the performance of bonds with different maturities may be more important than the forward guidance itself. Pimco has also previously stated that the Fed's balance sheet has shrunk by over $2 trillion from its peak of nearly $9 trillion, and if it continues to shrink gradually and predictably, the impact on broad financial markets may be relatively limited. However, BBH's interpretation of Warsh's remarks suggests that he is inclined to create space for rate cuts by reducing the Fed's balance sheet of about $6.7 trillion; the issue is that reducing the balance sheet may reduce systemic liquidity, change the demand for bank reserves and the maturity structure of government debt, and if not handled properly, may raise term premia. Therefore, for the 10-year Treasury, the real focus in the future will not be whether the Fed holds a few fewer press conferences, but whether the "speed of reducing the balance sheet, government debt supply, the withdrawal of dot plots and forward guidance, and the upward trend in inflation expectations and oil price shocks" resonate. For the global bull market dominated by the AI computing frenzy, the continuously rising demand for AI computing logic has not been negated, but the valuation system of how much investors are willing to pay for future years of cash flows of AI-related hot tech stocks will be reconsidered by the market. If the Fed under Warsh reduces forward guidance, increases bond market volatility, keeps the 10-year yield above 4.5% in the long term or even expands it further, then high valuations, high leverage, high percentage of future cash flows, and remote future cash flow realization for AI-related popular tech stocks will face greater valuation pressure. The 10-year Treasury yield, as the risk-free rate anchor on the denominator end of the DCF stock valuation model, once it remains high, the ongoing rally based on the super bull market around AI trends will not necessarily end, but will face temporary downward pressure and may even continue from the "valuation expansion bull market" to the "earnings verification bull market." A rise in the 10-year Treasury yield often significantly compresses the valuations of high P/E semiconductor, AI software, non-profitable AI infrastructure, power fuel cells, quantum computing, and space technology assets; but for the leaders in AI hard assets with locked-in orders, pricing power, buyback capabilities, and cash flows, the impact is more likely to be temporary volatility, rather than a collapse of the industry logic. For popular global AI tech stocks, cryptocurrencies, and other risk assets, the critical threshold is roughly in the range of 4.5%-4.8% for the 10-year Treasury yield. Technical analysis data shows that if the 10-year Treasury yield surpasses the region of 4.70%-4.80%, it may confirm an upward trend in yields; as the risk-free rate continues to rise, the equity risk premium will be compressed, significantly limiting the room for equity market valuation expansion. This means that as long as the 10-year yield remains around 4.5%, the market can rely on the AI profitability markup and risk appetite supported by the AI computing infrastructure construction frenzy; but if the yield effectively breaks through 4.70%-4.80% and even approaches 5%, driving global stocks to move towards a bull market, those high valuation tech assets/popular AI tech stocks associated with AI will face stronger discount rate impacts.