- Key insight: Federal Reserve Chair Kevin Warsh is slated to give a speech Friday at the Jackson Hole Economic Symposium, historically a keynote event that he will likely use as an opportunity to reestablish the central bank's credibility with markets by explaining how the Fed will respond to changing economic conditions.
- Supporting data: PCE inflation rose 3.7% over the past year, while the 10-year Treasury yield held around 4.66% and the 30-year around 5.18% Thursday.
- Forward look: Treasury's efforts to contain long-term borrowing costs complicates the Fed's reading of bond markets and means banks need to consider extreme shock scenarios.
For Federal Reserve Chair Kevin Warsh, it's showtime.
Bankers and the broader financial markets will be eagerly tuning in to Federal Reserve Chair Kevin Warsh's keynote speech at the Jackson Hole Economic Symposium in Wyoming Friday morning — an important address under any circumstances, but one that is especially important for Warsh in this moment.
Warsh has made
But that strategy comes as markets are dealing with high long-term Treasury yields and a cloudy outlook over the path of monetary policy. Given a marketplace eager for reassurance and Warsh's avowed reticence, experts say Warsh could placate investors by explaining how the Fed would respond to future economic conditions, though they expect few specific commitments.
"I think he'll do some basic things like reaffirm the 2% inflation target, which he's been doing consistently since he became chair," said Mark Zandi, chief economist at Moody's Analytics. "I think he'll take some solace in the better inflation numbers we've gotten over the last couple of months and make a case that inflation is moving in the right direction."
But Zandi said markets will also want Warsh to provide more clarity on why he has resisted forward guidance.
"I'm hopeful that he'll give us a better sense of his communication strategy, because that goes to credibility," Zandi said. "He's taken a pretty — at least so far — strident perspective on not providing any kind of forward guidance or any other guidance. So he's got to give us some sense of what his logic is and how he's thinking about that."
Isaac Wheeler, managing director of balance sheet strategy at Derivative Path, said Warsh may be able to maintain his tight-lipped approach characteristic of his first two FOMC meetings, while finding his own way to signal his seriousness about tackling inflation.
"If he continues to beat the drum on the Fed's price-stability mandate, that may be sufficient to restore some credibility," Wheeler said.
Unclear market signals
The speech comes amid a period of prolonged instability in the Treasury market, persistently high inflation readings and a significant underemployment problem that may be masked by nominally healthy unemployment reports.
The yield on long-dated Treasury bonds has spiked in recent weeks amid concerns about government borrowing and fiscal policy. Treasury Secretary Scott Bessent announced a move to expand government debt buybacks last week, a move that some observers say blurs the boundary between the Fed's monetary policy mandate and Treasury's responsibilities for debt management.
Derek Tang, CEO of Monetary Policy Analytics, said Treasury's recent actions reveal growing concern about rising yields, pointing to Treasury's intervention in the dollar-yen market and its planned increase in buybacks as part of that pattern.
"To me, I saw it as the latest in a series of actions that Bessent is taking to prevent the treasury yields from rising," Tang said. "So it's just a series of events that clearly reveal anxiety in the U.S. Treasury that treasury yields could go up too much."
The interventions could also make it harder for the Fed to interpret the Treasury market as a signal about the economy.
"From the Fed's point of view, especially from Chairman Warsh's point of view, the Treasury market is supposed to be a more pure signal of what's happening with the inflation outlook, with the growth outlook, and so forth," Tang said. "And clearly, that signal is now being muddled. It's being interfered with by the actions of the Treasury."
Warsh's speech also comes as the economic fundamentals seem to remain stubbornly difficult to read. This week, the Fed's preferred inflation gauge, the PCE,
At the same time, jobless claims remained relatively low on paper, but that topline number may obscure underlying weakness in employment. Former Comptroller of the Currency Gene Ludwig's Ludwig Institute for Shared Economic Prosperity reported that the U.S. functional unemployment rate, known as the True Rate of Unemployment,
Most expect the Fed to continue to hold rates steady at its September meeting, but markets will be sensitive to any signals from the chair. Treasury yields had moved little as of Thursday, with the 10-year around 4.66% and the 30-year around 5.18%.
Zandi said he expects Warsh to discuss broader forces affecting inflation and growth, including productivity, demographics and globalization. Warsh also has reason to avoid getting ahead of the Fed's
"He's set up these task forces to consider different aspects of the conduct of policy, and I don't think he wants to front-run them," Zandi said. "He's still new to the job, and I don't think he wants to try to break any new ground. At least not yet."
Walking the line
A big challenge for Warsh will be the increasing intersection of the Treasury's management of the bond market and the Fed's management of monetary policy, which raises questions about where the Fed's responsibilities end and Treasury's begin.
"How are we supposed to interpret these market prices?" Tang said. "How much of it is the market collectively giving a judgment, and how much of it is really the Treasury putting its thumb on the scale?"
Warsh will have to navigate that tension carefully, says Zandi, who called it "a tough, narrow path to walk on" and "difficult to make everyone happy."
"These are all efforts to lower interest rates, which, in my kind of simplistic view of the world, is monetary policy," Zandi said. "So the executive branch is getting into the Fed's lane, and to make sure that they don't take over the highway, I think he's got to be quite judicious about how he approaches things."
Zandi said the immediate market reaction will be the clearest measure of how Warsh's remarks land. He said Warsh would likely be satisfied if the 10-year stayed steady or saw a modest decline.
"I think the benchmark is the 10-year Treasury yield, that's the real-time report card we're going to look at," Zandi said. "He'd be thrilled if the 10-year yield fell a little bit, but I think the best he can hope for is that the 10-year yield doesn't move one way or the other … maybe a basis point or two, but nothing more than that."
Wheeler said Warsh could ease pressure on the long end of the yield curve by reaffirming the Fed's price-stability mandate and its gradual approach to balance-sheet reduction.
"Warsh can calm markets by continuing to lean on the Fed's price-stability mandate, and by reaffirming that balance-sheet reduction remains a slow, deliberate, multi-year process rather than an active lever," Wheeler said. "If Warsh successfully hits on both points, you'd expect some bull flattening, yields easing at the long end while the front end holds where it is."
For banks, the uncertainty around the yield curve means relying less on a single rate forecast and more on stress testing and evaluating multiple scenarios. Tang said banks are likely to broaden the range of scenarios they use and should account for extreme scenarios because shocks can come in waves and interact with each other.
"The number of scenarios will now be more varied because there's just a higher level of uncertainty," Tang said. "Even the extreme scenarios should be tested now because we're just in a world where a lot of shocks could come from unexpected sources, and also these shocks could compound."
Wheeler said the traditional approach of managing balance sheets around a single rate forecast is becoming less useful.
"So banks can't manage to forecast," Wheeler said. "In an environment with legitimate two-way rate risk, the best strategy is buying optionality where the market will sell it cheaply and monetizing it where it's gotten expensive."
Zandi said banks are similarly unlikely to change their baseline forecasts despite the volatility.
"They remain unchanged despite all the drama, the wild fluctuations in market expectations, the run-up in 10-year yields," Zandi said. "You don't even know what you don't know. They'll consider the risks. They have scenarios that they'll play out, but at the end of the day, I don't think their baseline forecast changes."
