Written by: Bao Yilong
Warsh officially took over the Federal Reserve, but was hit hard by the market on his first day in office.
On Friday, May 22, Trump presided over a swearing-in ceremony at the White House, formally handing over the reins of the Federal Reserve to Warsh. Warsh takes over the Fed as the surge in energy and transportation costs triggered by the Iran war continues to transmit into inflation.
As reported by Wall Street Insights , on the same day, Federal Reserve Governor Waller delivered a hawkish speech, clearly stating that inflation is the "driving force" for future policy decisions, and that future interest rate hikes and cuts are "50/50." This statement directly fueled a sharp rise in expectations for interest rate hikes.
The US Treasury market was sold off that day, with the yield on the interest rate-sensitive 2-year Treasury note rising 4 basis points to a new high since February of this year.
(This week's trend of yields on major US Treasury maturities)
The futures market has already fully priced in the expectation of a 25 basis point interest rate hike this year.
(The market expects the Federal Reserve to raise interest rates by 25 basis points this year)
TS Lombard economist Steven Blitz bluntly stated that if Walsh chooses not to raise interest rates when he chairs his first monetary policy meeting in June, the market will not give him any leeway.
Waller's hawkish shift makes inflation a policy "driving force".
At the same moment Warsh was sworn in, Federal Reserve Governor Waller delivered his most hawkish signal to date in a speech in Frankfurt entitled "Policy Risks Have Changed," a shift in stance that drew significant market attention.
Waller stated:
Inflation is not moving in the right direction, and I support removing the 'dodging bias' wording from the policy statement to clearly convey that the likelihood of rate cuts and rate hikes is now roughly equal.
He further pointed out:
I can no longer rule out the possibility that interest rate hikes will be necessary if inflation does not fall back soon.
Waller admitted that recent labor market reports and inflation data led him to change his previously long-held dovish stance.
He also stated that the oil price shock might subside soon, but emphasized that this does not mean "interest rate hikes should be considered in the near future," and that interest rate hikes require a "de-anchoring" of inflation expectations.
The minutes of the Fed’s April meeting previously showed that “many” officials had leaned toward abandoning the dovish bias, including three regional Fed presidents who disagreed on this issue in the April statement. Waller’s latest remarks corroborate this trend.
With Walsh's debut imminent, the pressure of the June meeting is immense.
Warsh will chair the Federal Open Market Committee (FOMC) meeting for the first time in mid-June, and market observers are not optimistic about the situation he will face.
The Federal Reserve's preferred inflation gauge has risen to its highest level in three years, with overall price growth reaching 6% in April. The market's implied one-year inflation expectation is around 4%.
TS Lombard economist Blitz stated that if Warsh decides not to raise interest rates in June, even if economic growth remains robust and far from overheated at that time, the market will interpret it as a form of de facto easing. Blitz said:
Against the backdrop of widespread rising inflation risks, failing to raise interest rates in June is effectively tantamount to easing.
KPMG's chief U.S. economist, Diane Swonk, pointed out that the situation in the Middle East has exacerbated existing price pressures. She said:
This is one of the many reasons why the Federal Reserve could not ignore the war and its inflationary impact.
The current market expectation of a 25 basis point rate hike by the Federal Reserve stands in stark contrast to the market's widespread bets on multiple rate cuts at the beginning of the year.
(Comparison of changes in market expectations regarding the Federal Reserve's interest rate trend around February this year)
Despite the impact of lower energy prices this week, the 10-year US Treasury yield did not rise significantly.
However, Goldman Sachs' George Cole points out that while long-term US Treasuries are slightly cheaper relative to their fair value, their valuations have not yet deviated to a level sufficient to support a deeper rebound.
(Long-term US Treasury bonds are slightly cheaper relative to their fair value)
George Cole emphasized that, before a substantial change occurs in the macroeconomic risk landscape, long-term yields will continue to face supply pressures and structural upward risks in the debt financing cycle.
A test of independence: hidden concerns behind a historic moment of inauguration.
Warsh is the first Federal Reserve chairman since Greenspan to be sworn in at the White House, a detail that has been seen as a signal by the market.
Trump is hoping that the former Federal Reserve governor, whom he nominated in January, will be more compliant with calls for interest rate cuts. Warsh beat White House economist Hassett, Waller, and BlackRock executive Rick Rieder in the nomination race.
The pressure to maintain the Federal Reserve's independence has been particularly pronounced recently.
Wall Street Insights reported that Jeanine Pirro, a Trump ally and U.S. Attorney for the District of Columbia, launched a criminal investigation into Powell over the Federal Reserve's $2.5 billion headquarters renovation project. The investigation has been dropped, but Powell stated that it was a pretext to pressure officials to cut interest rates.
Warsh is assuming a four-year term, becoming the 17th Chairman of the Federal Reserve's Committee on Chairs.
However, the market has made it clear that regardless of the political environment, inflation is the most pressing issue at present, and the new president has almost no time to make strategic plans.
