Warsh Strikes the Right Chord

Fed Chairman Kevin Warsh struck the right chord in his Jackson Hole speech yesterday. He noted that the Fed has missed its 2% inflation target for five years and the economy is operating at full employment. Although there has been some modest improvement in the recent inflation data, Warsh remains skeptical that it is on a clear glide path towards 2%. Although not giving forward guidance in the traditional sense, Warsh put the markets on notice that a rate hike is likely at the September Open Market Committee meeting.

 

The treasury market responded with a “bear flattener” where short rates went up much more than long rates. The 2-year surged by 12 basis points to 4.36% while the 10-year and 30-year yields advanced by 5 basis points and 2 basis points, respectively. The market action on Friday was the mirror image of the response after Warsh’s comments after the July Fed meeting. Then the market put on a “bear steepener” trade with short rates falling and long rates rising significantly. (See: Shulmaven: The Bond Vigilantes Strike)  I would remind readers that the 10-year treasury is trading at 4.72%, precisely the level when Treasury Secretary Scott Bessent announced his expanded bond buyback program. (See: Shulmaven: The Treasury Strikes Back )

 

Whether a September rate hike is one-off or the start of new tightening cycle remains to be seen. However, with the 2-year note yielding 4.36%, it looks like the federal funds rate is now on a slow road to 4.5%.