Wednesday's Fed meeting and Fed Chair Press Conference served as a "Declaration of Independence" for Kevin Warsh in today's politicized environment. Recent gains in U.S. Treasury yields underscored the stakes as "bond vigilantes" are demanding more and more "term premium" (higher yields) to account for inflation eating away at "real yields." The 12-0 vote itself was a statement after divided votes at the past few meetings. Warsh said: "Price stability is foundational to economic growth, and I think we took an important step today to deliver it. We did it in part by removing the dose of accommodation… What we can do, and will do, is ensure that any change in relative prices don't broaden out, don't have second- and third-order effects on the economy." Recent developments in the Iran war, involving damage to Saudi Arabia's major pipeline and attacks in the Strait of Bab al-Mandab, could cause a new level of oil supply shocks further stoking inflation. Energy prices are part of "headline inflation," and markets are concerned that broadening price increases could affect "core inflation."
What's next? The Fed usually hikes or lowers in cycles. The "dot plot" of predictions from Fed Committee members for year-end 2026 shows 16 of 17 members indicating one or two more hikes this year. The Fed Funds Futures indicates a 60% chance of a hike in October and a 90% chance of at least one hike by year-end. Warsh prefers less forward guidance, less "Fedspeak," where governors prognosticate in between meetings. Treasuries rallied, with yields dropping around 8 bps. The hike and comments most likely forestalled a sell off. See chart below, the 2-year Treasury yield tracks market expectations for the Fed Funds rate. As of now, it seems to be predicting 50 bps of increases. Stay tuned…
Chart of the Day — Fed Funds Rate vs. 2-Year & 10-Year Treasury Yields. Source: FRED, Federal Reserve Bank of St. Louis.
By David R. Pascale, Jr., Senior Director at George Smith Partners.
