Woofun AI reports that Federal Reserve Chair Jerome Powell is set to face intense congressional scrutiny during his debut testimony before the House Financial Services Committee and the Senate Banking Committee, where he is expected to defend a communication strategy that explicitly rejects forward guidance in favor of a data-dependent reaction function.

The foundation for this contentious approach was laid on July 2, when Jerome Powell publicly announced that he would not provide forward guidance on future policy moves, stating instead that the central bank would meet in four weeks. He characterized the upcoming internal discussions as a "family argument", noting that while the committee would engage in thorough debate behind closed doors, he could offer no further information to the public. This deliberate opacity sets the stage for his appearances on Tuesday and Wednesday at 10 p.m. Beijing time, where lawmakers are anticipated to press him relentlessly on inflation and interest rates, though Powell’s recent remarks suggest he will continue to withhold clear answers.

Structurally, the Federal Reserve’s semi-annual monetary policy report, submitted to Congress last Friday, reinforces this stance by asserting that the Fed "will achieve price stability" despite persistent inflation. The report highlights that under certain quantitative policy rules, the implied federal funds rate exceeds the current target range of 3.5% to 3.75%, yet it explicitly warns against mechanically interpreting these rules, arguing that such prescriptions ignore the dynamic economic outcomes that result from following a rigid path. This nuance is critical as yields on Treasury bonds have continued to rise since the beginning of the year, with markets already pricing in higher interest rates.

Per Woofun AI, the timing of the testimony coincides with the release of key inflation data on Tuesday, meaning Powell may be questioned about the Consumer Price Index (CPI) on the very day he testifies before the House. Market forecasts anticipate that June’s CPI inflation rate will drop to 3.8% year-on-year from 4.2% in May, driven by falling oil prices, while core CPI, excluding food and energy, is expected to decline slightly to 2.8% from 2.9%. Despite this potential cooling, Powell’s established communication style suggests he will likely avoid providing a clear assessment of the data, maintaining his focus on the broader economic trajectory rather than specific monthly fluctuations.

The minutes from the June policy meeting reveal that most Federal Reserve officials see two possible paths for interest rates this year, hinging entirely on whether inflation declines. If inflation cools, rates may remain steady or even fall; however, if inflation persists, further tightening may be necessary. The minutes outline a stringent scenario where strong demand driven by artificial intelligence, ongoing conflicts in the Middle East, or the continued impact of tariffs keep inflation high while the labor market remains stable, leading almost all officials to believe it is necessary to "tighten policy to some extent." This ambiguity underscores the market’s uncertainty not just about the direction of rates, but about how Powell will respond to evolving economic conditions.

The debate over Powell’s approach centers on the distinction between forward guidance and a reaction function, a concept clarified by Andrew Sacher of Bloomberg Economics, who notes that forward guidance tells the market the expected route, whereas a reaction function explains how the central bank will respond to surprises without providing a predetermined path. Richard Berner, a professor at New York University who worked on the Fed’s research team in the 1970s, emphasizes that good communication conveys this reaction function—the relationship between economic conditions and policy interest rates—which he argues is truly essential and distinct from forward guidance. This debate has extended within the Fed itself, with Governor Lael Brainard distinguishing between the two in a speech in Rome, arguing that explaining policy responses in different environments reduces uncertainty for markets and households.

Market reaction to Powell’s silence has been mixed, with Powell defending his communication style on July 1 in Portugal by pointing to bond market performance as evidence that volatility has fallen rather than risen. He suggested that critics do not understand the market’s actual comprehension of the Fed’s stance.

However, Michael Feroli, JPMorgan’s chief U.S. economist, criticizes this approach, arguing that if Powell continues to remain silent, he may hand over the initiative in Fed communication to other policymakers, leaving the market to rely on other officials to understand the Fed’s view of the economy. This lack of centralized clarity raises concerns about the coherence of the Fed’s messaging.

Beyond inflation and rates, Powell faces questions on central bank independence, particularly in light of Trump’s preference for low interest rates, with Powell reaffirming that the Fed has long been an independent central bank and that no change will be seen in that regard. Artificial intelligence is another key topic, with Powell acknowledging that AI’s impact is visible on the demand side and will eventually affect the supply side, potentially boosting productivity and lowering inflation. To address these complex issues, Powell appointed five task forces to study public communication, balance sheet policy, data quality, inflation views, and AI’s impact on productivity and employment, areas that the semi-annual report notes could influence future policy implementation.

Powell’s communication strategy is also reflected in institutional changes, such as his absence from the submission of quarterly economic forecasts used for the "dot plot" in June, the significant shortening of post-meeting statements, and the condensation of minutes released three weeks later. While some officials support this reevaluation of communication practices, others warn that if the new method makes it harder for outsiders to understand the Fed’s assessment, support may wane. Lou Crandall, chief economist at Liteson Yilianhuiye, recalls the "absurd chaos" of the 1980s when the Fed did not publicly communicate interest rate decisions, noting that Alan Greenspan’s vague wording led investors to bet on minor clues, including the thickness of his briefcase. Don Kohn, former vice chair of the Fed, argues that while it is understandable for a new chair to take time to sort out thoughts, this situation cannot last forever, as the Fed must eventually provide more detailed economic views. This historical perspective highlights the critical need for clarity in the reaction function, a lesson learned over the past three decades.