- Key insight: Federal Reserve Chair Kevin Warsh hailed rising market interest rates between Federal Open Market Committee meetings as a positive development.
- Expert quote: "Market participants are learning to play the ball, not the referee, and market prices will continue to respond in the direction and magnitude they see fit. This is, in my view, a change for the better, and we're just getting started." — Federal Reserve Chair Kevin Warsh
- Forward look: Warsh's comments suggest he will be steadfast in his commitment to limited communication, even if it creates volatility in markets. He said the Fed also won't raise rates simply because markets do.
WASHINGTON — Federal Reserve Chair Kevin Warsh said his limited approach to communication might have contributed to record jumps in Treasury yields since the Fed's June monetary policy meeting. He also said it was a positive development.
"Market participants are learning to play the ball, not the referee, and market prices will continue to respond in the direction and magnitude they see fit," Warsh said during his post-Federal Open Market Committee meeting on Wednesday. "This is, in my view, a change for the better, and we're just getting started."
The FOMC voted 9-3 during its July meeting to keep the federal funds rate between 3.5% and 3.75%, with the three dissents coming from a trio of reserve bank presidents who would have preferred a quarter-point rate increase.
In his prepared remarks, Warsh said Treasury yield increases between the two meetings were "among the most significant in the last two decades." He noted that the increases were seen across the maturity spectrum for bonds and constituted not just nominal increases, but real ones — meaning they exceeded the growth implied by inflation.
In the immediate aftermath of the FOMC's policy decision to hold rates steady for a fifth straight meeting, 2-year Treasury yields — historically the most strongly correlated with the federal funds rate — fell sharply by about 7 basis points. Yields on 10-year government bonds fell initially after the Fed's announcement then rallied to its highest level of the day.
Bond traders were not the only financial market participants divided over what to expect from the Fed on Wednesday. Futures traders in the federal funds market were split 70-30 over whether the FOMC would hold or hike.
Warsh has made pulling back on communication that could be considered forward guidance about the path for monetary policy a staple of his eight-week tenure at the Fed. He has said that the central bank performs better when it tracks market movements rather than the other way around. So far, he said, that approach is working as planned.
"By not spoonfeeding markets, by not previewing our decisions, by not giving nudges and leans, my colleagues and I have found in the inter-meeting period is … instead of just repeating or echoing what we are saying back to us, [markets are] giving us somewhat, not perfect, [but] their own judgment," he said. "Surprises are not the objective, but at the same time, I would say we didn't come into this meeting feeling constrained by the full range of alternatives we had in front of us."
At the same time, Warsh said the FOMC did not interpret the changes in bond yields as an indication that it needed to raise its benchmark rate to meet market expectations. Instead, he framed the ultimate result of Wednesday's meeting as the committee positioning itself for its next move.
"If I look at the Treasury curve, if I look at the dollar, I look at a lot of things that are internals inside of financial markets, I think what they're broadly saying is that this committee does own [its objective to stabilize prices], has the credibility to deliver it, and they believe, like I do, that we will," Warsh said. "But … we've got no magic wand. This is not something that we're going to be able to carry out in days or weeks, but we're going to deliver on the responsibility that Congress gave us. And today's meeting and the preparation for today's meeting was an important step towards that destination."
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Warsh was resolute in insisting that the Fed would meet its policy objective of 2% inflation. He also said the most recent inflation report, the consumer price index from the Bureau of Labor Statistics, had "not much" to do with the committee's ultimate decision to hold. The report showed prices rose 3.5% year over year in June, an improvement from the 4.2% increase tracked in May but still well above the Fed's target.
When pressed on the issue of his "reaction function" — meaning what would cause him to favor raising or lowering the Fed's policy rate — Warsh said he was broadly inclined to favor higher rates when inflation was high and employment is full and lower rates when inflation is low and employment is full. While the former scenario appears to describe the current economic condition, Warsh declined to spell out why exactly he did not favor a rate cut this week.
Instead, he reiterated his broad commitment to lower prices eventually.
"This FOMC has been in business for eight and a half weeks. The impatience that households and businesses feel has been going on for 63 months," Warsh said. "We are on the job. We will deliver. We are focused like a laser on making sure we can do it. But the suggestion that we're going to be able to do it with our magic wand is one I want to disabuse you and everyone else of, but the discussion the last [few] days gives me more confidence even than I had eight-and-a-half weeks ago."
