Fed Chair Warsh Holds Rates Steady, but Hawkish Tone Keeps 10-Year Yield Near 5%
The US central bank skipped a second hike, yet its stern wording gave bond markets reason to keep long-term borrowing costs elevated.
The US Federal Reserve left interest rates unchanged at its latest meeting, but its tone was firm enough that the 10-year Treasury yield stayed around the 5% mark. The analysis behind this story says almost every line of the short policy statement leaned hawkish, even though no rate hike followed.
Before the decision, the 10-year yield had hovered just under 5%, as if waiting for the outcome. It rose at first, then slipped back to 5% and briefly below once Chair Kevin Warsh spoke. He sounded reassuring on inflation expectations, saying they had been tamed somewhat.
The analyst's read is less calm. Warsh defines price stability as strictly 2% inflation and seems serious about it. But inflation is still elevated, the Fed is on hold, and inflation expectations actually rose after the decision. That is enough, the analysis argues, to justify the yield moving back above 5%, with a path toward 5.25% still in view.
Short-term yields behaved differently. The 2-year yield edged lower because markets liked the pause. The Fed has so far delivered just one 25-basis-point hike, and holding gives the economy time to feel it. The analysis suggests the Fed may end up less aggressive than its words imply. The result is a steeper yield curve, with more of the same expected in coming weeks.
On the balance sheet, little changed. Policy rates and mechanisms stay as they were, and the Fed will keep reinvesting principal from mortgage-backed securities into Treasury bills. Warsh wants a smaller balance sheet, but a concrete plan is probably some way off, with committee recommendations expected nearer the year-end. Funding markets look stable, with repo functioning far better than a year ago.
Attention now shifts to Europe. The European Central Bank meets Thursday and is not expected to change rates, though markets already price in about 23 basis points of tightening by December. The bigger questions for Christine Lagarde concern bond market turmoil in France and how far the ECB might go to contain it. The expected sequence runs from toned-down rhetoric, to pausing quantitative tightening, to the Transmission Protection Instrument, though the bar for the last steps looks very high.
Why it matters: higher long-term yields push up borrowing costs globally, from mortgages to emerging-market debt. Read the original analysis here.
