Markets are set for a much more hawkish Warsh Fed than expected
Federal Reserve Chairman Kevin Warsh’s tough talk on inflation Wednesday reverberated through financial markets, with traders expecting that the central bank could start jacking up interest rates in just a few months.
Tapped to serve by President Donald Trump, who has repeatedly demanded lower rates, Warsh during a news conference instead focused on the battle against inflation, which has run above the Fed’s official 2% target for five years.
“Persistently high prices are a burden for the American people, but the recent past need not be prologue,” he said. “I am pleased to report that members of the [Federal Open Market Committee] are unambiguous and unanimous. This committee will deliver price stability.”
Markets immediately took notice as the new central bank leader sought to establish his inflation-fighting credentials.
The 2-year Treasury yield, seen as a market reflection of Fed moves, soared as Warsh spoke.
At the same time, futures market traders began placing bets on when the next rate hike would come. The probability for an increase at the July 28-29 meeting quickly climbed to about 1 in 3. Odds for a September hike spiked to 67% around midday Thursday, according to the CME Group’s FedWatch gauge.
2-year yield
Dispelling the Warsh narrative
Moreover, traders priced in largely tighter Fed policy well into the future, too.
The odds of a second hike by September 2027 rose above 45%. Even further out, the market-implied fed funds rate for May 2031 stood at 4.78%, indicating as many as five hikes in as many years from the current target range of 3.50%-3.75%.
A popular narrative that Warsh was sent to the Fed to ease monetary policy at all costs was quickly dispelled within the space of a 40-minute parley with reporters. At times serious and other times light-hearted, the session was notable for the inflation focus, with Warsh referring to “price stability” a dozen times.
Market veteran Ed Yardeni said he was “blown away” by Warsh’s remarks.
“We thought he was a dove who favored lowering the federal funds rate (FFR) because he believes that AI is boosting productivity and economic growth while keeping a lid on inflation,” the head of Yardeni Research said in an overnight note. “Instead, he hammered home a strict, orthodox message on inflation with a strong commitment to price stability.”
The pivot to inflation fighter shook investors, with stock market averages diving along with the spike in Treasury yields.
But apprehension about a possibly hawkish Warsh Fed dissipated Thursday as Wall Street digested the FOMC meeting outcome and focused more on positive developments in the Iran war and the prospect for lower energy costs ahead. Stocks rallied and yields were flat to lower.
Some positives on inflation
There seems reason for optimism that the chairman’s position in retrospect could be seen as a good deal of saber-rattling amid what might already be positive prospects for inflation. Even with popular inflation gauges at…
