Walsh's 'Unified Front': Aiming for Rate Cuts?

Personnel arrangements, framework restructuring, dovish turn, all pointing towards interest rate cuts in the fourth quarter.

Written by: Zhao Ying

Source: Wall Street Insights

The policy framework reform promoted by Federal Reserve Chair Walsh has entered a substantive phase. With the official announcement of the leadership teams for five working groups on July 9, this internal restructuring, viewed by outsiders as a 'unified front', is advancing along a clear three-step roadmap—its ultimate goal may be the restart of interest rate cut discussions in the fourth quarter.

The leadership list released by the Federal Reserve includes heavyweight figures such as former Bank of England Governor Mervyn King, former Reserve Bank of India Governor Raghuram Rajan, Silicon Valley investor Marc Andreessen, Harvard University economics professor Greg Mankiw, and Nobel laureate Thomas Sargent, covering global central banks, top academia, and the tech industry. The five working groups will evaluate monetary policy communication, balance sheets, economic data, productivity and employment, and inflation frameworks, and submit research reports by the end of the year.

Previously, adjustments to the PCE statistical methodology announced by the Bureau of Economic Analysis (BEA) have prompted warnings from institutions like Goldman Sachs and UBS: the related changes will systematically lower core PCE inflation readings. CITIC Securities also released a research report before the working group list was announced, linking these movements into a complete policy narrative: personnel arrangements, framework restructuring, dovish turn, a three-step approach targeting interest rate cuts. The formal establishment of the working groups seems to validate this judgment.

Five Working Groups Launched, Bridging Central Banks, Academia, and Silicon Valley

According to the Federal Reserve's announcement on July 9, each of the five working groups is co-led by three experts from different fields, supported by Federal Reserve staff.

The Monetary Policy Communication Working Group is co-led by Mervyn King, Peter Fisher, a professor at the Foster School of Business at the University of Washington and former senior official at the U.S. Treasury, and Arminio Fraga, former president of the Central Bank of Brazil and founder of Gávea Investimentos. The group will focus on assessing how the Federal Reserve can improve its policy communication in uncertain environments.

The Balance Sheet Working Group is led by Harvard University economics professor Karen Dynan, Raghuram Rajan, and former Federal Reserve Governor Jeremy Stein, and will systematically evaluate the costs and benefits of quantitative easing, quantitative tightening, and the long-term reserve system.

The Economic Data Working Group consists of Harvard University economics professor Raj Chetty, former Walmart CEO Doug McMillon, and University of Chicago economics professor Kevin Murphy, focusing on improving the quality, timeliness, and usability of economic indicators.

The Productivity and Employment Working Group, the most tech-oriented arrangement in this reform, is led by Marc Andreessen, co-founder of Andreessen Horowitz, Stanford University economics professor Charles Jones, and Microsoft executive vice president Asha Sharma, focusing on assessing the impact of general-purpose technologies like AI on productivity, the job market, and long-term growth potential.

The Inflation Framework Working Group is composed of Greg Mankiw, Thomas Sargent, and former economic adviser to the Bank for International Settlements William White, and will re-examine the Federal Reserve's framework for analyzing inflation drivers and formulating policy responses.

Walsh stated in a statement that each working group will carefully assess whether the methods, analytical tools, and policy paths adopted by decision-makers can be further improved, with a very clear goal of ensuring that the Federal Reserve can perform its duties in the best possible state during this critical period.

PCE Statistical Methodology Quietly Adjusted, Goldman Sachs and UBS Warn Inflation Readings Will Be Lowered

Before the working group list was announced, another clue had quietly emerged.

The BEA announced that it would make methodological adjustments to three components of the PCE price index, which will officially take effect on September 30, 2026, and will retroactively adjust historical data. According to reports from trading desks, Goldman Sachs and UBS released research reports indicating that these changes will systematically lower core PCE inflation readings.

Among the three adjustments, the most significant impact comes from the investment management services component. The current method directly uses the nominal expenditures deflated by the PPI for that industry. Due to rising asset prices pushing up management fees, this component has seen a year-on-year increase of 21.6% over the past 12 months, making it the second-largest contributor to core PCE inflation. The new method will use total hours worked from employment surveys to measure 'real service volume', and since hours worked are growing much slower than asset size, the calculated price increase will drop significantly. UBS economist Alan Detmeister and others estimate that this change will reduce core PCE year-on-year inflation by about 0.21 percentage points.

For the computer software and accessories component, Goldman Sachs analysts Manuel Abecasis and others estimate that the new method will lower core PCE year-on-year inflation by 0.05 to 0.1 percentage points in May and by 0.1 to 0.2 percentage points in December. The adjustment to the legal services component will cause inflation to rise slightly by about 0.04 percentage points in May, partially offsetting the downward effects of the previous two components.

Considering the three changes, both Goldman Sachs and UBS believe the net effect is a systematic downward shift in core PCE inflation readings. UBS more directly pointed out that the choice of changes 'seems aimed at lowering inflation' and warned that the new method lacks transparency, making it difficult for outsiders to independently verify, posing a risk of data manipulation.

CITIC Securities: A Three-Step Roadmap, with the Endpoint Being Rate Cuts

CITIC Securities researcher Qian Wei released a research report before the working group list was announced, interpreting this series of movements as part of a complete policy framework.

The report argues that since Walsh took office, he has faced multiple challenges, including a weak internal foundation at the Fed, questions about its independence, and differing stances. His core task is to complete the 'unified front' at the Fed, planned to be advanced in three steps.

The first step (July): Personnel arrangements. By establishing a committee to balance the appointments of working group personnel, core policy positions are granted to the working groups, which will subsequently take on some tasks of guiding market expectations.

The second step (third quarter): Framework adjustment. Traditional employment and inflation indicators are subject to significant short-term fluctuations and are difficult to reach consensus on, while the AI revolution provides Walsh with an opportunity to introduce a new supply-side framework. The core logic of the new framework is: rising productivity can control inflation, thereby creating space for monetary easing. CITIC Securities cites the period from 1995 to 1998, noting that despite high wage growth and a strong economy, the trend of labor productivity growth was upward, inflation fell, and the linkage between wages and prices was broken by rising productivity, leading the Federal Reserve to ultimately choose to cut rates.

The third step (fourth quarter): Stance transformation. With the groundwork laid in the first two steps, the Federal Reserve turns dovish, and discussions on rate cuts are restarted. CITIC Securities points out that currently, labor productivity growth is climbing, wage growth is declining, layoffs in the tech sector are occurring, and the job market is not tight, 'essentially mirroring 1999'. If employment and CPI data moderately align, the final conclusions of the working groups are likely to help the Federal Reserve shift to a dovish stance, with rate hike discussions receding.

From the timeline perspective, the establishment of the working groups seems to validate the internal logic of this narrative—personnel arrangements have been completed, and framework adjustments and re-interpretations of inflation data are advancing in sync.

The Inflation Framework Working Group will re-examine the Federal Reserve's methodology for analyzing inflation, the Economic Data Working Group will study how to improve indicator quality, and the Productivity and Employment Working Group will provide academic support for the new supply-side framework. Together, these three efforts form a complete loop paving the way for rate cuts.

Walsh stated that the U.S. economy 'has undergone tremendous changes over the past generation, and the pace of change is unprecedented', and the Federal Reserve needs to re-examine its policy tools and analytical methods. Each working group will submit research reports by the end of the year, at which point the contours of the policy framework adjustments will become clearer.

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