Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Bond Market Is Testing the New Fed Chair
Transcript
- Lucas: So Kevin Warsh gets sworn in as Fed chair on Friday, and the bond market is already sending him a pretty clear welcome message. Luna: Which message — the ten-year yield sitting at four point six one percent, or the fact that the curve is still flattening? Lucas: Honestly, both. The ten-year has crept up about twenty basis points over the past month. And the two-year? It's at three point five eight, so the spread between two and ten is just over a hundred basis points. That's not screaming recession, but it's not exactly a vote of confidence in long-run growth either. Luna: Right, because normally if the market expected the Fed to cut soon, the long end would be lower. Instead we've got this steady grind higher. Lucas: Exactly. The narrative that's been circulating — you saw it in that Yardeni quote — is that 'bond vigilantes' are going to force the Fed to hike in July. The logic is that inflation isn't coming down fast enough, and the market is pricing in that risk. Luna: Let's look at the actual inflation numbers we have. April CPI came in at three three two point four, up from three three zero point two nine in March. Core CPI at three three five point four. That's still above the Fed's target. Lucas: And core PCE, which is the Fed's preferred measure, was at one two nine point three in March, up from one two eight point nine. The ten-year breakeven inflation rate actually dipped a bit to two point four four percent, but that's still above two percent. So the market isn't convinced inflation is defeated. Luna: But the Fed funds rate is at three point six four percent effective. If they hike in July, that would bring it to, what, three point eight nine or so? Lucas: Probably twenty-five basis points. The question is whether Warsh wants to start his tenure with a hawkish move or whether he'll try to talk the market down first. Luna: He's been pretty quiet since the nomination. No major speeches, no interviews. That's unusual for someone about to take the chair. Lucas: It is. And I think the market is interpreting that silence as uncertainty. Or maybe he's just waiting for the swearing-in to set his own tone. But in the meantime, the bond market is doing the talking. Luna: Speaking of which, let's take a quick pause here. If you're finding these macro conversations useful and you want to keep the show ad-free, listener support is what makes that possible. Buy me a coffee dot com slash fexingo — that's literally all it takes. Lucas: Yeah, we don't run ads, and that's a deliberate choice. If today's episode helped you make sense of the bond market or the Fed, buy me a coffee dot com slash fexingo is the place. Now back to the yield curve. Luna: So the ten-year at four point six one — how does that compare to where it was when Powell was chair? Lucas: It's actually not that far off. The ten-year peaked around five percent in late 2023. But the context is different now because the economy is slowing. Real GDP growth annualized is only two percent for the first quarter, up from a very weak zero point five in the previous quarter. So growth is positive, but not strong. Luna: And the labor market is still tight but cooling. Nonfarm payrolls at one fifty-eight point seven million, job openings down to six point eight six million. Initial jobless claims are at two hundred nine thousand, which is low historically, but the trend is creeping up. Lucas: Right. So you've got an economy that's not overheating, inflation that's sticky but not accelerating, and a new Fed chair who hasn't signaled his playbook. That's a recipe for the bond market to test him. Luna: What do you think Warsh's first move should be? Does he need to hike in July just to establish credibility? Lucas: I think he would be smart to use the June meeting to lay out a clear framework. Maybe signal that a July hike is on the table if data doesn't cooperate, but not commit to it. The danger of hiking prematurely is that you tighten into a slowdown. The danger of waiting is that inflation expectations become unanchored. Luna: And the bond market is essentially doing the tightening for him right now. Higher long-term yields mean tighter financial conditions without the Fed having to move. Lucas: That's the irony. If the ten-year stays at four point six or goes to four point seven, that's a de facto tightening. The Fed could actually afford to hold steady and let the market do the work. Luna: But then you risk the 'bond vigilante' narrative becoming a self-fulfilling prophecy. If the market thinks the Fed is behind the curve, yields could spike. Lucas: Exactly. And that's the tightrope Warsh walks when he takes the oath on Friday. He inherits an economy with two percent growth, four point three percent unemployment, and inflation above target. The bond market is watching every word. Luna: What about the international picture? We've got the uk gulf trade deal, Putin-Xi talks on a gas pipeline, and the AI economy reshaping the labor market. Does any of that feed into the Fed's calculus? Lucas: The AI story is interesting because it could boost productivity and potential growth over time, which would be disinflationary. But in the near term, it's mostly noise for the Fed. The Putin-Xi pipeline deal is more about geopolitics and energy markets. If it lowers energy prices, that helps inflation. But it's a long-term play. Luna: So bottom line: the bond market is the main event. Warsh is stepping into a chair where the market is already pricing in a July hike. He can either validate that or push back. Lucas: And we'll know a lot more after his first press conference, which I assume will be in June. The tone of his opening statement will matter as much as the dots. Luna: And if he does hike in July, what's the risk to the growth story? Lucas: The risk is that two percent real GDP growth doesn't have much buffer. If the Fed tightens too much, you could see growth slip below trend. The unemployment rate could tick up. But if inflation is still running above target, they might be willing to accept that trade-off. Luna: All right, we'll be watching the swearing-in on Friday and the data releases between now and the June meeting. Lucas: And we'll be back tomorrow to talk about what Warsh says in his first public remarks. Thanks for listening.