NEW YORK—When questioned about future rates in his April confirmation hearing to lead the Federal Reserve, Kevin Warsh answered that “unlike many of my colleagues past and present, I don’t believe in forward guidance.” The term refers to a central bank’s practice of either committing to future policy actions by “tying itself to a mast,” or of at least providing hints about its future intentions. Staying true to his word, in the first months of his term, Warsh has cut the length of Federal Open Market Committee (FOMC) statements by providing fewer details about inflation and employment and limiting signaling about future rates.
When the Federal Reserve began forward guidance in the early 2000s, it served an important purpose in managing market expectations. The guidance helped avoid a liquidity trap, in which businesses and consumers hoard cash, when nominal interest rates were near zero. Since then, the communication tool has gathered many supporters, who have cited better monetary policy transmission, more accountability, and less-sudden price jumps as benefits. However, among other consequences, it has suppressed volatility—a side effect upon which markets now rely. But, suppressed volatility does not disappear entirely; it accumulates.
Where this volatility accumulates is the question that the debate around forward guidance has ignored. Analysis of Warsh’s cutback of forward guidance has so far centered primarily around US markets, but this isn’t the full picture. Equally important to consider are the emerging markets that absorbed the risk appetite forward guidance created. These economies have long understood that suppressed volatility feeds unhealthy capital, which swiftly exits during crises, leading to recurrent boom-bust cycles. For these countries, the pivot away from forward guidance can potentially promote healthier capital flows.
Forward guidance and the experience of emerging markets
To understand why, it’s first useful to consider how forward guidance operates in markets, and why its curtailment is better understood as a change in policy, not merely in communication. Greater communication lowers the market’s uncertainty about near-term rates, dampening short-term volatility and inviting investors to take on more risk than they might otherwise. But in times of crisis, this volatility can reappear as a larger systemic shock. In this sense, forward guidance does not make volatility disappear. It defers it by selling it forward.
As a naturally riskier asset class, emerging markets attract investors when global risk appetite is high—or, in other words, when measured volatility is low. Sometimes the shift is discretionary, with investors relaxing risk limits and rotating out of safe assets into higher yielding emerging market debt when extra yield looks cheap. Other times it is mechanical and occurs through the balance sheet. Global banks and leveraged funds size their positions against measured volatility, so when that measure falls, they can borrow without breaching a limit. But in all instances the compression of global volatility leads to a search for yield that lands in emerging markets. This is known as the “risk-taking channel of monetary policy.”
The channel is now more intense and policy relevant than ever, as the last decades have seen a rapid increase of capital flows towards and from emerging markets, as the first chart below shows. These have also correlated strongly with persistent current-account deficits in these economies, amplifying the risks of a potential sudden stop.
The issue is that capital drawn in by this process is rarely there to stay. It arrives more often in response to external liquidity conditions than any measured assessment of a country’s economic fundamentals. And it remains there only until a shift in global benchmarks prompts its withdrawal. Economists describe these flows as “hot money”: in a crisis, these positions unwind and reverse into a sudden stop. Inflows become outflows, the local currency depreciates, and domestic borrowing costs rise sharply as affected countries experience “twin” or even “triple” crises.
The International Monetary Fund’s (IMF’s) April 2026 Global Financial Stability Report estimates that a one-standard deviation increase in the CBOE Volatility Index (VIX), the standard global gauge of risk, reduces quarterly emerging market portfolio debt flows by around 0.3 standard deviations, or close to 1 percent of gross domestic product. That same channel does not significantly affect advanced economies.
Research on the global financial cycle has also shown that a single global factor, shaped substantially by US monetary conditions, accounts for around a quarter of the variance in risky asset prices worldwide. The most mobile share of that capital now travels through exchange-traded funds (ETFs), which respond to global risk some 2.5 times more strongly than conventional mutual funds, since holders trade the asset class as a whole and are generally indifferent to any individual country.
A return to market equilibrium
The history of emerging markets is filled with counterintuitive cases where well-managed, market-oriented, and fiscally prudent economies have been caught in a retrenchment they did nothing to provoke. This is because, for them, the global liquidity cycle is a better predictor of capital flows than economic fundamentals. As such, financial openness is very much a double-edged sword, and it is for this reason that the IMF has incorporated the preemptive use of certain capital flow measures (CFMs) into its policy arsenal for the developing world. As three case studies from recent years show in the charts below, “hot money” held by investment funds and hedge funds is particularly sensitive to risk episodes.
A Federal Reserve that guides markets less, and therefore compresses global volatility less, may weaken these cycles. A higher baseline level of volatility should, all else equal, raise the cost of the short-dated instruments, such as carry trades and leveraged positions, that feed boom-bust cycles in emerging markets. This is a return to market equilibrium, given that forward guidance’s suppression of volatility was in the first place a distortion.
The change also affects how development is financed in emerging markets. The end of forward guidance means that capital allocation in emerging markets should become more responsive to fundamentals. If this occurs, then the economies that have undertaken the difficult work of institutional reform are more likely to be rewarded for it in retaining and attracting capital. Economic freedom, the security of property rights, and the rule of law—attributes the Atlantic Council’s Freedom and Prosperity Indexes measure—would then become more reliable predictors of which economies retain durable capital.
Foreign direct investment and long-dated local-currency debt motivated by healthy fundamentals sustain investment and entrepreneurship. In effect, the end of forward guidance will remove some of the excess liquidity that masked weak institutions and reward countries that have invested in strengthening their institutions.
Moving forward without forward guidance
There are, of course, caveats. A higher volatility floor implies a higher risk premium on emerging-market assets, which can stifle healthy funding. A global liquidity crunch would still affect emerging markets at large, and countries that are unprepared might find themselves swimming naked when the tide goes out. And a return to more minimal communication does not do away with the need to anchor expectations during a crisis.
The appropriate response, then, is not to lament the passing of forward guidance but to determine what ought to replace it. Less guidance need not entail less transparency. The Federal Reserve must still be clear and consistent about the analytical framework that underpins its decisions, enabling the market to do what it is best at—price discovery.