Wasabi referred to AI as a reason not to pigeonhole immediately, and the interest rate response market had to figure it out for itself?

TL;DR

· Lagarde and Powell signaled at the Sintra Forum: Central banks will reduce complex forward guidance, relying more on data and reaction functions.

· The interest rate path is harder to predict in advance, with bonds, the dollar, and risk assets potentially more sensitive to inflation, employment, and AI investment data.

· Related assets: US Treasuries, the US Dollar Index, interest rate futures, AI concept stocks, gold, Bitcoin, and crypto assets.

At the end of June and the beginning of July, at the European Central Bank's Sintra Forum, ECB President Lagarde and Kevin Warsh, who became the Fed Chair on May 22, both presented the same message to the market: central banks no longer want to commit to a complex interest rate path.

In the past, many trades relied on central bank hints about the next steps, such as when to cut interest rates, how many more rate hikes, and where the terminal rate would be. Now, central banks prefer to explain which data they are looking at and how they will react. Investors will have to figure out for themselves what will happen at the next meeting.

This is not a simple hawkish or dovish switch. With central banks providing fewer answers, the market will rely more on inflation, employment, consumption, and business investment data. Bond yields, the dollar, tech stock valuations, gold, and crypto assets are all more likely to be repriced based on individual data points.

Central Banks Breaking the Habit of Answers

Forward guidance (previously indicating the policy direction) was an important tool for central banks over the past decade. After the financial crisis, with interest rates near zero, central banks needed to use language to influence expectations, so they would more clearly tell the market how long low rates would be maintained.

The current environment is not conducive to such commitments. Supply chain shocks post-pandemic, energy prices, geopolitical risks, tariff changes, and the AI investment cycle have all made it harder to predict inflation and growth. If central banks spell out the path in advance, they could end up being bound by their own words.

In her opening speech at Sintra, Lagarde mentioned that in an uncertain environment, the value of complex forward guidance diminishes, and ECB decisions will rely on data and be made on a meeting-by-meeting basis. She emphasized the use of framework guidance instead of path guidance.

Warsh's statement was more direct. According to the AP, he refused to provide forward guidance at Sintra and was unwilling to give detailed hints about future interest rate paths. He believes that the market and the real economy operate better when observing real data and making their own judgments.

For the market, central banks are taking some of the pricing work back. Previously, the market tried to interpret the answers provided by the central banks, but now the market has to understand how the central banks are posing the questions.

Framework Guidance Provides Only Scoring Criteria

Framework guidance (explaining decision rules) can be understood with a simple analogy: forward guidance is like revealing the answer in advance, while framework guidance is like informing about the scoring criteria.

The central bank's scoring criteria are the reaction function (policy reaction rule). It broadly answers three questions: whether inflation will return to target, whether there have been changes in wages, demand, energy, and supply chain pressures, and whether the transmission of past policies to the economy has taken effect.

If the central bank explains the rule clearly, the market theoretically can adjust in advance when new data is released. If oil prices rise but wages do not follow, the market may believe the central bank will not overreact. If core inflation and wages stick together, rate expectations will shift up again.

This mechanism is appealing to central banks because it preserves flexibility. The central bank does not have to commit to cutting rates three months later, nor does it have to explain why it changed course after an impact has occurred. It just needs to explain how policy will respond if the data looks a certain way.

Investors' difficulty will also increase. Is a inflation data point a short-term noise from energy or persistent pressure from service prices and wages? Is a slowdown in employment the beginning of an economic soft landing or the start of demand falling apart? These judgments will directly affect rate futures and bond yields.

AI Is Not a Reason to Immediately Turn Dovish

AI is the most easily misunderstood part of this discussion. Many investors naturally think that if AI boosts productivity, improves corporate efficiency, and reduces inflationary pressures, could the central bank relax policy earlier?

The central bank's answer is more cautious. Powell acknowledges that AI will have a huge impact on monetary policy and also mentions that AI investments will first bring a capital expenditure boom. However, in the short term, investments in data centers, chips, energy, and infrastructure may initially result in increased demand rather than price decreases.

AI could enhance long-term economic supply capacity and may also drive up investment, electricity usage, financing, and asset valuations in the short term. The central bank cannot overlook the still elevated inflation currently just because of potential future productivity gains.

Powell emphasized in the same discussion that price stability remains the primary goal. If anyone thinks the Fed will tolerate inflation above 2% for a long time, they will be disappointed. This constraint limits the market's ability to directly translate the AI narrative into a quicker rate cut scenario.

Silence Does Not Equate to Easing

When central banks no longer provide a clear path, the market tends to interpret silence as a shift. Especially when inflation is moderating at the margin and oil price pressures are easing, investors are inclined to trade for easing in advance.

But the signal released by Sintra is closer to another implication: the central bank does not want to be tied to any single path. As inflation continues to recede, it can cut rates. If inflation re-sticks, it can also maintain high rates or even tighten further.

This will change the rhythm of asset pricing. Rate trades will be more reliant on monthly data, long-term bonds may endure higher volatility. The dollar will oscillate between a longer maintenance of high US rates and slowing growth. AI stock valuations will be supported by both the productivity narrative and constrained by real rates.

The logic behind gold and crypto assets will also become more complex. Policy uncertainty and market fluctuations may increase hedging demand, but if high rates persist for longer, non-yielding assets will still face valuation pressure. They cannot simply be categorized as trades that benefit from central banks staying quiet.

Inflation Data Tests New Communication

Whether this new mode of communication can hold up ultimately depends on whether it can anchor expectations. If the market can still understand the central bank's reaction function after the lack of clear guidance, bond and risk asset volatility may rise, but not necessarily spiral out of control.

The pressure point remains inflation. A short-term fall in energy prices may mitigate some risks, but whether core inflation and service prices continue to decline will determine if the central bank has room to ease. As long as price pressures remain high, the AI productivity narrative will find it difficult to immediately become a reason for a dovish turn.

The upcoming meetings of the Federal Reserve and the European Central Bank will test whether this communication strategy is actionable. The market will be looking not only at the rate decisions themselves, but also whether the central banks are truly reducing path hints while clearly explaining their reaction functions.

If central banks only reduce commitments without providing a comprehensible judgment framework, investors will face not a more transparent market, but one that is more high-frequency and subject to more intense data trading.

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