If new Federal Reserve Chair Kevin Warsh has not, he should watch the new movie adaptation of Homer’s “Odyssey.” Among his many trials, Odysseus was strapped to the mast of his ship and later sailed between that famous rock and a hard place – but not at the same time. Warsh is attempting them simultaneously: resisting the bond market’s hawkish siren song even as he navigates policy between high inflation and the White House’s call for rate cuts.
That’s a lot to handle. In his press conference at last week’s Federal Open Market Committee (FOMC) meeting, which resulted in holding rates steady, Chair Warsh boasted that bond yields are “higher today than they were 42 days ago. Markets have made decisions because we stepped back in part from trying to influence those.” But the bond market expressed displeasure with the Committee’s inaction. Thirty-year US Treasury yields spiked and the yield curve steepened. Its message: if you say you will curtail inflation but then do not raise rates, you have lost credibility.
But the Fed did meet investor expectations. Fed funds futures projected the target range would remain at 3.50-3.75%, which it did. They even essentially predicted some dissent (three voters wanted that elusive 25 basis-point hike).
Higher for longer is music to our ears.
As usual, the short end of the yield curve acted more rationally – and not just because a cash manager is saying so. It actually declined after the meeting, suggesting the money markets do not anticipate imminent tightening. That also is my view. The US economy cooled in the second quarter, as did inflation in June. While the resumption of hostilities in the Middle East might reverse the latter’s course, a pause in rate action is defensible. Chair Warsh should not be faulted for letting it play out. It also is unfair to construe the lack of rate hikes as a sign he is a US President Donald Trump sycophant. Let’s not forget that the financial markets love to punish new Fed leaders for a “policy mistake” early in their tenures. That surely is part of this tantrum.
But if a hike does arrive in autumn, the money markets should benefit. The industry as a whole has experienced volatility this year in large part because of cash raised to fund several massive IPOs. But we think demand is steady and will only increase if rates stay at present levels or rise. Higher for longer is music to our ears.
Forward guidance workarounds
Part of the blame for the bond market backlash is on Chair Warsh for reducing traditional forward guidance and creating a task force to potentially curb it more. But investors will eventually get used to it. Deciphering FedSpeak and the FOMC statement has always been difficult. We simply will have try harder and perhaps rely more on innuendo.
Of course, it was inevitable that someone would tap artificial intelligence (AI) to help. Institutions such as Brandeis University already have built machine learning prediction models. But last month saw the launch of a bot with a name playing off ChatGPT. We at Federated Hermes leverage AI but are certainly not abandoning traditional legwork and research.
Cook v. Trump ruling not the end
The US Supreme Court’s decision that embattled Fed Governor Lisa Cook can remain is unlikely to be the conclusion of President Trump’s campaign to appoint someone sympathetic to low interest rates. He vowed to overturn what he termed “a procedural matter,” though nothing substantial has emerged. But he apparently has a Plan B – as in Governor Michael Barr. Barr was the Fed’s Vice Chair for Supervision when Silicon Valley Bank dissolved in spring of 2023. He stepped down from that position in early 2025, apparently also to avoid a fight with the White House, but can remain on the board until 2032. Current Vice Chair for Supervision Michelle Bowman commissioned a probe to investigate the bank’s foundering, which the administration might leverage to remove Barr. Whether or not either tactic gets traction, these developments likely mean that former Chair Jerome Powell will remain on the Fed Board.
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