Kevin Warsh’s vow to modernise the Fed could result in the adoption of new cutting-edge data sources like prediction markets.
It is a new era for the US Federal Reserve, the world’s most-watched central bank, whose sway over interest rates is foundational to the nation’s financial and economic policy. Newly appointed chairman, Kevin Warsh, convened his first Fed meeting last week, and although the Federal Funds Rate was left unchanged at 3.5%-3.75%, Warsh signalled that overhaul is coming, and that could include the utilisation of prediction markets as new data research tools.
US markets have risen to record heights in recent months in an AI and industrial-led frenzy, but many leading gaming stocks have lagged due to various headwinds. Lower interest rates would be welcomed by companies, but prospects for future rate cuts are fading in the face of economic fallout from the Iran war and sticky inflation.
As of writing, the probability of zero cuts this year is now 75% on Kalshi and 80% on Polymarket. On 1 January, Kalshi traders were predicting three cuts, and two cuts was the favourite on Polymarket. That type of real-time, real-money data seems to be of great interest to the Fed under Warsh, who said at his first press conference on 17 June that the bank is forming a task force to analyse its “use and reliance” on existing data sources.
This data task force will “evaluate new information sources and consider methodological changes to improve data gathering, with the aim of giving policy makers more accurate, relevant, contemporaneous, and perhaps most important actionable information”, Warsh told reporters. He later called the Fed’s current data sources “old fashioned” and said he’s “open minded that there are a lot of new data sources that we can learn from the private sector” without naming anything specific.
Reached by iGB this week, a spokesman for the Fed declined to comment for this story.
End of forward guidance?
Warsh never mentioned prediction markets by name, but they represent perhaps the best example of the kinds of new-age financial data sources he seeks to adopt.
As federally licenced exchanges, recreational and institutional traders from across the US now trade dozens of prediction market contracts related to factors that weigh into Fed rate decisions, including projections on inflation, employment reports, the Consumer Price Index and the gross domestic product. Although these contracts garner considerably less volume than sports and political markets, numerous economists have begun to question if they are more accurate than traditional surveys and polls.
Of the economic markets, the most popular at any given time are typically projections for the Fed’s next meeting and the rest of the year. The Fed has long been in the practice of giving its own forward guidance at meetings, and since 2012 board members have marked their individual projections on “dot plots” that are published quarterly. Warsh has been a staunch critic of these practices and was the only board member to not offer a projection in this quarter’s plot.
Another task force Warsh aims to implement is focused on Fed communications, and he indicated that its work might conclude by year’s end. He told reporters last week he expects the body will “propose some well-considered changes” and declined to confirm whether it will fully cease offering guidance and dot plots. If that were to happen, Fed-related prediction markets could become a kind of proxy for outlets to report. Currently, Kalshi is partnered with CNBC and Polymarket is partnered with Dow Jones, publisher of the Wall Street Journal.
Prediction market data could play into Fed decisions
The idea of analysing prediction markets in the course of Fed policymaking was first broached earlier this year. In February, researchers Anthony Diercks, Jared Katz and Jonathan Wright published a working paper titled “Kalshi and the Rise of Macro Markets” under the Fed’s Finance and Economics Discussion Series portal. While Diercks serves as principal economist and special advisor to the Fed, the paper was authored independently and is not representative of or endorsed by the bank.
“Prediction markets offer high-frequency, continuously updating forecasts that can complement central bank decision-making,” the paper said. “High-frequency data let us apply an event study methodology to see how news shapes beliefs about macroeconomic indicators.”
Researchers were complimentary of prediction market financial data, in this case from Kalshi, describing it is “well-behaved, responsive to news and comparable in forecasting accuracy to established benchmarks”. The breadth of contracts available also means that traders are establishing new data sets that weren’t previously available, researchers said.
“In several cases, they provide unique insights – particularly for variables like GDP growth, core inflation, unemployment and payrolls, for which no other market-based distributions currently exist,” the paper said.
