The 10-year Treasury rallied this week down to 4.37% (currently) after opening the week at 4.51%. Markets are hopeful that inflation will ease as oil prices dip below $70 per barrel, levels last seen before the Iran war disruption (down 27% from the April high).
Speaking of inflation, yesterday's "hot" PCE report came in at 4.1%, the highest reading since April 2023. Core PCE came in at 3.4% (0.3% month over month). Markets shrugged off the news as the figures matched analyst forecasts.
Personal spending and incomes accelerated 0.7% month over month, indicating that U.S. consumers are still spending despite higher borrowing costs. However, recent data indicates some stress on low- and middle-income consumer balance sheets.
Regime Change: As one analyst remarked after the June 16 Fed Meeting, "There's a New Chairman in Town."
Kevin Warsh wasted no time in putting his imprint on the Fed, starting with the publication of the opening statement:
- Forward guidance was removed. Warsh: "It's not well suited for the current policy conjuncture." The easing "bias" in previous statements was removed entirely (note that the last Fed meeting featured a "revolt," as multiple committee members demanded the bias be removed because they feared Warsh would be overly dovish). Bottom line: future Fed meetings will feature clearer (less wordy) communications with less prognostications regarding future direction (which markets would endlessly ruminate on and react to).
- No naming of individual voters on the Fed rate decision (just the general tally).
- The "dot plot," which shows Fed voters' predictions of future interest rates, was missing one "dot" (Warsh did not submit a prediction and avoided reporters' attempts to goad him into one). He remarked that committee members submitted their dots "in pencil."
Today, Treasury Secretary Bessent piled on: "I do applaud Chair Warsh's getting rid of forward guidance. I think that that is kind of a crutch that market participants have started leaning on."
- No "balance of risks" assessment and no mention of "full employment," but it ended with the unambiguous line that "the Committee will deliver price stability."
As if that wasn't clear enough, Warsh threw down the gauntlet in the press conference: "We are unambiguously and unanimously committed to delivering price stability. The Fed has missed the inflation target for five years, and we are going to fix that."
The assumed "dove" revealed himself as a "hawk." This served as a declaration of independence for the Warsh Fed during a complicated political environment. He reasserted the Fed's role as the protector of our currency.
The U.S. dollar immediately rallied — which also spurred the rally in Treasuries. Treasury buyers need to have confidence that the underlying currency is stable, or they will require "term premium" (a.k.a. higher rates).
Warsh also calmed concerns regarding the size of the Fed's balance sheet (which has grown substantially over the years since the GFC, as the Fed purchased bonds to stimulate the economy). Although he has advocated for a smaller balance sheet, he understands that selling off bonds too quickly could remove liquidity from the economy.
The new statement "reaffirmed" the Fed's so-called "ample-reserves regime" (code for the large balance sheet). This reassured markets that the Fed won't make drastic sudden moves in this regard. He also announced task forces (more change). The scope of the new task forces encompasses the breadth of the Fed.
The committees will tackle 5 major concepts:
- Communications
- Balance Sheet
- Data Sources (definitely a subject that needs updating, as markets are sick of endless "revisions")
- Productivity in the Era of Transformation (how will AI disruption change the game on the Fed's "dual mandate" of high employment and low inflation?)
- Inflation Frameworks (drivers of inflation, the Fed's responsibility for inflation, and how inflation is measured)
This is widely seen as a review of the 2020 "Flexible Average Inflation Targeting" (FAIT) framework adopted under Powell, which allowed inflation to run above 2% to make up for prior shortfalls — a policy many now blame for the 2021–2023 inflation surge. Note that Warsh has been explicit that the 2% target itself is not on the table. Warsh: "I see no reason, until we have reestablished our commitment and ability to deliver on the 2% inflation objective, to revisit that."
What is likely to change is the strategy for hitting 2%, possibly adopting a more rules-based approach to rate-setting. Stay tuned…
