Nobody's sure where the Federal Reserve is heading

Predicting what the Federal Reserve will do next has become an exercise in trying to game out the tactical instincts of a new chairman who isn't giving the world much to work with.

Why it matters: While it's early days in the Kevin Warsh chairmanship, his reaction function — the way he is likely to respond to incoming information about the economy — is a black box.

• It means that a wide range of possibilities for interest rate policy this year remain in play — from multiple rate hikes starting in late July, to leaving rates steady indefinitely.

• Warsh's policy direction should become clearer once he speaks more publicly and as incoming data sheds light on how quickly the inflationary pressures unleashed by the Iran war will recede.
• To some extent, the mystery is, in Warsh's long-held view, more of a feature than a bug. He believes that the Fed ought to spend less time talking and more time doing and that it's hardly the worst thing in the world if that leaves traders offsides on a surprise policy move now and then.

State of play: Inflation has been above the Fed's target for five consecutive years. But there's debate over how much of the recent excess inflation has been due to one-off factors, including higher tariffs and supply disruptions from the closure of the Strait of Hormuz.

• There is the empirical question: How much of the 3.4% rise in the Fed's preferred inflation measure over the last 12 months reflects ongoing price pressures?
• There's also the question of whether the Fed may need to tighten policy to help regain credibility that it is truly committed to keeping inflation near 2%, given its half-decade record of failure on that score.

Zoom in: In his first news conference last week, Warsh didn't offer much of an answer on either point. "I can't give any forward guidance about what we're going to do next," he said. "The good news is, we'll be meeting in six weeks."

• That has left the Fed-watching community thinking of the world in a range of scenarios, depending on how Warsh and the policy committee he leads settle on both the economic analysis and tactical choices.

What they're saying: "Given the uncertainty surrounding Warsh's reaction function, we present two potential rate paths in our updated probabilities," Tim Duy and Josh Lehner of SGH Macro Advisers wrote in a note.

• In one path, the Fed sticks with former chair Jerome Powell's Fed's tolerance of ongoing inflation on a bet that the economy will return to 2% inflation as one-time factors recede. In another, it makes a sharper break and raises rates.
• "Subjectively we think the odds favor the regime change path, but lacking forward guidance we acknowledge that assessing Warsh's reaction function is a learning by doing exercise," they wrote.

What's next: Warsh will have at least two major opportunities to refine public understanding of the direction of interest rate policy before the next policy meeting at the end of July.

• On Wednesday, he is scheduled to appear on a panel at the European Central Bank's high-profile conference in Sintra, Portugal.
• And in mid-July, he will appear before Congress for the semiannual monetary policy testimony prescribed by law.

The bottom line: Those of us who make a living trying to understand what the Federal Reserve is up to have had it easy for the last dozen years or so.

• Listen carefully to what the Fed chair says in press conferences, note the dot-plot of officials' interest rate projections, mark to market with the latest data on the labor market and inflation.
• Not anymore.