An economist says there a 3 reasons Kevin Warsh is right to nix Fed guidance, and flags one thing he can do to calm markets

Photo 1 by Victor J. Blue/Bloomberg via Getty Images; Photo 2 by Al Drago/Bloomberg via Getty Images

• Apollo economist Torsten Sløk said Kevin Warsh is right to nix forward guidance from the Fed.
• He said it gives the Fed flexibility, though at the cost of greater volatility in markets.
• Sløk says there's one thing Warsh can do to help quell bouts of volatility in reaction to Fed decisions.

The market may have freaked out after the last Fed meeting, but a top economist says chairman Kevin Warsh is getting it right when it comes to how the central bank communicates.

Warsh's decision to end forward guidance from the Fed has been met with criticism, but Apollo's chief economist Torsten Sløk praised the new chairman's call, even if markets don't appear to like it.

Sløk wrote in a blog post that he supports Warsh's call, and that there are three reasons it's way for the central bank to go about conducting monetary policy.

"Fed Chair Kevin Warsh has been unfairly criticized," he wrote. "The decision to eliminate forward guidance isn't reckless. It's pragmatic."

Here's why Sløk is onboard:

• It can prevent policy inertia by not locking the central bank into rate paths.
• It can improve real market signals by letting prices adjust as new data comes available.
• It can stop false certainty by ending predictability and forcing investors not to treat a rate path as a certainty.

In Sløk's view, the central bank should prioritize flexibility and market accuracy over the old forward guidance framework. However, he does see one change Warsh could make that that would soothe jittery markets ahead of future policy decisions.

"Warsh could dampen this newly introduced volatility by providing clearer framework guidance," he said. "Without it, markets struggle to understand how the Fed will reach 2% inflation. Is it through higher rates, a smaller balance sheet or tighter financial conditions? This uncertainty has steepened the yield curve and pushed up risk premiums."

When Sløk responded to Warsh's July press conference, he noted that a critical component of the Fed's credibility depends not just on stating its goals for the economy, but making it clear how they intend to accomplish them.

Warsh's announcement that they would continue withholding forward guidance triggered a selloff in markets, making it clear that investors were not happy with the new communications style. But Sløk maintains that if the Fed prioritizes clearer framework, eliminating guidance can end up benefiting markets.

"By eliminating forward guidance, the Fed gets more flexibility," he said. "But higher volatility is the cost, and the cost can be minimized by providing clearer framework guidance."

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