Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Fed New Chairman and the Breakeven Signal
Transcript
- Lucas: So Kevin Warsh just wrapped his first meeting as Fed chairman yesterday, and the bond market is already sending a pretty clear message about what it thinks of his approach. Luna: Clear meaning what exactly? Because the breakeven inflation rate ticked down again, right? Lucas: Exactly. The 10-year breakeven dropped to 2.25 percent as of June 18. That's down from 2.26 the day before, but it's been drifting lower for weeks. The market is essentially saying inflation expectations are cooling, even though CPI is sitting at 4.2 percent. Luna: And that's interesting because Warsh is seen as more hawkish than Powell was. You'd think if a hawk takes over, breakevens might go up on fears of tighter policy. Lucas: Right, that's the intuitive bet. But look at what's happening. The effective fed funds rate is 3.63 percent. Real rates — if you use the breakeven as a proxy for expected inflation — are positive. And the economy is still adding jobs. Nonfarm payrolls hit 159 million in May. Lucas: So the market might be pricing in that Warsh is credible enough to keep inflation anchored, even if the actual inflation number is sticky. That's a vote of confidence. Luna: You know, speaking of confidence — one thing I really appreciate about this show is that we deliberately don't run ads. It keeps the conversation clean, no interruptions. If you find value in walking through the economy with us, consider supporting that choice at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small way to keep this independent. And it really helps. Anyway, back to Warsh — the breakeven drop also aligns with the JOLTS numbers that came out for April. Luna: Job openings jumped to 7.618 million, up from 6.887 million in March. That's a big swing. Lucas: It is. And normally a surge in openings would suggest wage pressure and sticky inflation. But the breakeven is declining. So the market is looking past the labor market noise and focusing on the broader disinflation trend. Lucas: Warsh's first statement apparently emphasized data dependence and a flexible framework. That might be exactly what bond investors wanted to hear — not a rigid hawk, but someone who will adjust as inflation comes down. Luna: But we're still at 4.2 percent CPI. That's more than double the Fed's target. How flexible can he really be? Lucas: That's the tension. The breakeven is a market-based expectation, not a promise. If actual inflation doesn't come down, Warsh will have to act. But for now, the bond market is giving him the benefit of the doubt. Luna: And the 10-year yield itself is at 4.45 percent. That's down from where it was a few months ago. So yields are falling alongside breakevens — that's a classic growth scare signal. Lucas: Exactly. The nominal yield is dropping because real yields are dropping, not just inflation expectations. The market might be pricing in a slowdown. Real GDP growth annualized was only 1.6 percent in Q1 2026. That's not recession territory, but it's sluggish. Lucas: So Warsh inherits an economy that's growing below trend, with inflation still above target. It's a delicate balance. Luna: What about the geopolitical angle? The Iran deal headlines — that could shift oil prices and inflation expectations quickly. Lucas: That's the wild card. If the Iran situation stabilizes and oil falls, that's disinflationary. But if it escalates, energy costs spike and breakevens could reverse. Warsh's first few months will be shaped by external factors as much as domestic data. Luna: So the breakeven at 2.25 percent — is that a signal that the Fed can start cutting rates later this year? Lucas: The market is pricing in about one or two quarter-point cuts by year-end, according to fed funds futures. But Warsh hasn't signaled anything. He's holding the line at 3.63 percent for now. Lucas: If the breakeven stays low and the labor market softens, the pressure to cut will build. But if CPI stays at 4.2 percent, cutting would be a gamble. Luna: It feels like the bond market is betting on Warsh being more pragmatic than his reputation suggests. Lucas: That's exactly it. His reputation as a hawk was forged in the 2008 era. But the economy is different now. He's got a chance to redefine himself. Luna: And the breakeven is the market's way of saying they trust him to do it. For now. Lucas: Right. Trust is fragile. One wrong move — or one surprise inflation print — and that 2.25 percent could spike back to 2.5 percent or higher. Luna: So what's the one thing listeners should watch in the next month? Lucas: The July FOMC meeting. Warsh's first real decision point. If the breakeven stays below 2.3 percent and core PCE — which is at 129.6 — stays flat, he might signal a cut. If not, he'll hold. Lucas: Either way, the bond market has laid down its bet. Now we see if the new chairman plays along.