Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / What the Bond Market Is Saying About Warsh's First Week
Transcript
- Lucas: Kevin Warsh gets sworn in as Fed chair on Friday, and the bond market is already sending him a very clear welcome note. Luna: A note that says 'please raise rates,' if the ten-year yield is any indication. Lucas: Exactly. The ten-year Treasury yield closed yesterday at 4.57 percent — that's up about 2.5 percent over the past five days. The two-year, which is more sensitive to Fed policy, sits at 4.22. So the spread between them is now about 35 basis points. Luna: And that spread was inverted — negative — as recently as a few months ago. The curve is steepening in a hurry. Lucas: Right. A steepening curve typically means the market expects either stronger growth, higher inflation, or both. In this case, the inflation part is front and center. The latest CPI print came in at 332.4 for April, up from 330.29 in March. That's a 0.6 percent month-over-month increase — not huge, but persistent. Luna: And core CPI, excluding food and energy, also ticked up. So the narrative that inflation is 'almost licked' is taking a hit. Lucas: It is. And the market's response has been to price in a higher probability of a rate hike at the July FOMC meeting. Traders now see the next move as a hike, not a cut — a complete reversal from where we were six months ago. Luna: Ed Yardeni, the economist who coined the term 'bond vigilantes,' has been saying the Fed will have to raise in July to appease the bond market. You think Warsh walks into that pressure on day one? Lucas: I think he's acutely aware of it. Warsh is a market veteran — he served as a Fed governor during the financial crisis and has been vocal about the need for the Fed to respect market signals. He's not going to ignore a steepening curve and rising breakevens. Luna: The ten-year breakeven inflation rate is at 2.44 percent, down slightly from 2.49 a week ago, but still above the Fed's 2 percent target. So inflation expectations aren't running wild, but they're sticky. Lucas: Sticky is the right word. And that's arguably a bigger problem than a sudden spike, because it's harder to wring out of the system. You have to keep rates high for longer, or even nudge them up, to convince the market you're serious. Luna: Meanwhile, the real economy is sending mixed signals. GDP growth annualized came in at 2 percent for the first quarter — that's up from 0.5 percent in the prior quarter, so solid. But jobless claims just jumped to 211,000 from 199,000 the week before. Lucas: That's the highest level in several weeks. It's still low historically, but the direction matters. The Fed has a dual mandate — maximum employment and price stability. If the labor market starts to soften, raising rates becomes a harder sell. Luna: Especially with the unemployment rate at 4.3 percent, which is up from the 3.4 percent trough. It's not alarming, but it's a trend. Lucas: So Warsh comes in with a curve that's telling him to hike, a labor market that's telling him to be careful, and inflation that's still above target. Not an easy first week. Luna: Before we get too deep into the Fed-watching, I want to pause for a quick note. Lucas and I do this show because we love talking about this stuff, and we keep it free and ad-free because listeners make it possible. Lucas: Yeah, it's a small but mighty group. If today's episode was useful to you and you want to keep it that way, buy me a coffee dot com slash fexingo helps. That's literally the link. Luna: Even a few dollars a month makes a difference. We're grateful. Okay, back to the macro. Lucas: So one thing I'm watching closely is how Warsh handles the communication piece. The market is already pricing in a July hike, but the Fed hasn't signaled anything explicitly. If Warsh comes out in his first press conference and says something like 'the committee is data dependent,' that's one thing. If he says 'we are prepared to act if inflation doesn't moderate,' that's another. Luna: He's known for being direct. His past speeches have a certain bluntness that markets appreciate. But bluntness can also spook people. Lucas: Exactly. The S&P 500 is down about 0.9 percent over the past five days, and the NASDAQ is down 1.4 percent. Part of that is the rising rate environment, but part of it is uncertainty about the new chair. If Warsh sounds too hawkish, you could see a sharper sell-off. Luna: And the Russell 2000, which tracks small caps, is down 1.6 percent. Small companies are more sensitive to interest rates because they rely more on borrowing. So that index is taking a hit. Lucas: That's a good point. The small-cap weakness is a real signal about credit conditions. And if the Fed does hike in July, it will tighten financial conditions further, which could slow the economy. Luna: But if they don't hike, the bond market might sell off more — yields go higher — which also tightens conditions. So the Fed is in a bit of a corner. Lucas: That's the bond vigilante dynamic Yardeni talks about. Either you hike to appease them, or they force you to hike later at a higher cost. Warsh understands this better than most. Luna: So what do you think is his most likely first move? A clear hawkish signal at the swearing-in, or a wait and see approach? Lucas: I think he'll be measured but firm. He'll acknowledge the progress on inflation but stress that the job isn't done. And he'll probably emphasize the Fed's independence — that it will do what's necessary regardless of political pressure. Luna: That last part is key, especially with an election year coming up. The White House might prefer lower rates, but the bond market wants discipline. Lucas: Right. And the market has a longer memory than any administration. If Warsh wants to establish credibility, he has to show he answers to the data and the bond market, not to politics. Luna: We'll know more by Friday. For now, the macro picture is a tug of war between sticky inflation, a still-solid economy, and a labor market that's starting to blink. Lucas: And Warsh is the new referee. Should be an interesting few weeks.