This week the Fed hiked rates. This was hardly unexpected given that inflation remains above target, that growth looks solid, and that continuing inflationary pressures are very apparent. In such circumstances, a hold – whatever the President might desire – would have been much more noteworthy. 75% of respondents to the latest FTxBooth US Macroeconomists survey expected the move.
But things are not as straightforward as the simple ‘central bank raises policy rates in response to above-target inflation’ story would suggest.
The real story of the last few weeks for the US macroeconomy has played out in the bond markets. The yield on 10-year government bonds has flirted with, and occasionally breached, 5% in recent trading sessions. This has been accompanied by some oddly contradictory messaging from fiscal and monetary policymakers.
As is often the case with price moves in financial markets, there are competing (and not all mutually exclusive) theories as to what has driven the move. Optimists argue that higher rates reflect the market pricing in faster economic growth in the future, although cynics note that it seems rather suspicious that this outburst of economic hope coincides so neatly with the beginning of the conflict in the Gulf. Pessimists point to rising inflation, worries about policymaker credibility, or fears about excessive supply driven by large Federal deficits. Others note the role played by the AI capital expenditure boom in swallowing up savings and adding upward pressure for other borrowers
In the weeks leading up to the latest FOMC meeting, market participants had to deal with sharply conflicting views from US macro-policymakers.
Chairman Warsh got himself a bit tangled up in a communications mess, at least partially because of his views on the bond market. As previously discussed in this column, at the July FOMC press conference claimed that:
The first is a very notable change since our last meeting 42 days ago: nominal and real yields are materially higher across the Treasury curve. In fact, some of the increases in market interest rates between FOMC meetings are among the most significant in the last two decades, ranking around the top decile or so. But if the Committee didn’t change its policy rate, what happened? In the inter-meeting period, market attention centered on real data and real economic developments. Prices reacted in real time to incoming information, and the reduction in forward guidance may have been a factor.
… we need to observe market reaction to developments, direct and unfiltered.
In other words, because – he claimed – of a lack of forward guidance from the Fed, bond market pricing was providing useful signals on real-time economic data and acting as a guide to policy.
By this way of thinking, the bond market is some kind of an oracle and raw pricing, unsullied by policymaker nudges and winks, offers a valuable insight.
That line of argument certainly did not convince everyone and, as many expected all along, Chairman Warsh has been pushed into spelling out the Fed’s reaction function in more detail and even, although he would likely not use the exact term, into offering a bit more guidance about the likely path of rates in the near future.
But whether that argument was convincing or not, it is surely incompatible with the recent signals coming from the Treasury Secretary. To him, it has appeared over the last few months the bond market is less an oracle and more of an obstacle. Through a combination of verbal interventions – including recently describing pricing as like a ‘fever’ that will break – and through some actual policy changes, Secretary Bessent has attempted to push yields down. As the Economist notes this week:
On September 9th the Treasury offered to repurchase up to $6bn-worth of its bonds; on September 24th, and near-weekly thereafter, it plans to buy back tranches worth up to a maximum amount $4bn. Mr Bessent says he aims to “push things back towards equilibrium”—meaning to lower his government’s borrowing costs.
There is, of course, some irony to be found in the current pull-push effort between the monetary and fiscal authorities. The Fed Chairman wants to shrink the Fed’s balance sheet and stop offering guidance in an effort to get policymakers out of the bond market and to use it as a useful source of economic information. Meanwhile, the Treasury Secretary is ramping up efforts to directly impact prices and push yields down.
For market participants, this is all something of a mess.
Still, if the Fed has now embarked upon a hiking cycle – as seems likely – then it is unlikely the Treasury department can do a great deal to hold yields down. 66% of survey respondents expect the ten-year yield to be above 5% but below 5.5% one year from now and another 12% see it above 5.5%. The balance of 22% expects it to be between 4.5% and 5%, with no respondent thinking yields are heading below that level in a year’s time. In other words, the ‘fever’ is unlikely to break anytime soon.
