Walked the Walk
Doug Nolan
He Walked the Walk.
But will Chair Warsh anxiously backpedal at the first sign of trouble?
Kevin Warsh was masterful.
We’re left to ponder how much difference it might have made had he stayed at the Fed (or even led it earlier).
If only he could have somehow stifled the fateful doubling of the Fed’s balance sheet between 2011 and 2014. Reform at the finale of a historic Bubble is problematic on many levels.
Changes are afoot.
It was apparently the shortest in the modern era (post 2011) of post-meeting press conferences.
Journalists adjusted to a new alphabetically derived seating arrangement.
The Fed Chair’s relatively terse response to questions was notable.
Follow up questions have been revoked.
Warsh:
“Market participants and reporters, I think generally over the course of the last decade or so, have grown accustomed to waiting somewhat breathlessly on a data point.
That isn’t my view. I was not waiting breathlessly on what any particular data was…
I’ll just reiterate, trends matter.
Data points are noisy.
Data point dependence is a dangerous preoccupation.
It’s not something that concerns me.
Markets over time will come to understand how this Fed makes its decisions, what’s relevant and not, and I wouldn’t want to editorialize that for them beyond it.”
The Chair’s statement and comments were astute and credible.
“Economic activity is expanding at a solid pace.”
“Domestic spending has been resilient.
Productivity growth is strong, and capital investment is robust.”
“The American economy appears to be strengthening.”
“New hiring, private-sector earnings, business capital investment—each of these markers has improved in recent months.”
“Both job openings and weekly hours have been increasing.”
“Last month in Wyoming, I expressed my commitment to a monetary policy discipline, not to a decision.
I defined the standard for action: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed.”
The Chair’s “monetary policy discipline” is coming into clearer view.
“Too many categories are still posting increases above 3%, on both a 6- and 12-month basis.”
“Overall commodity prices also bear watching.”
“I’m not a data point dependent guy.”
“Trends matter.”
“We tend to look at aggregates around here.”
“There’s no hiding from hot spots around the world.”
The Chair is also not a “neutral rate” guy.
“I’ve always been interested in a neutral rate as an academic matter.
Back when I learned economics, we used to think of it as the Wicksellian rate, the real equilibrium rate.
It’s useful academically, it’s a discussion to help us think about policy.
Do I think it has any operational effect on decisions that we make today?
No, I don’t.”
Good riddance theoretical “R-star”, unseated (hopefully) by superior analytical focus of “money,” Credit and financial conditions.
Disregarded by Wall Street, the August 28th CBB (“Number Six”) underscored Warsh’s sixth of seven core principles:
“Money matters.
It’s not fashionable these days, but my view is that money has something important to do with monetary policy.
We should pay attention to money created by the central bank and money that comes from the banking and financial systems…”
Warsh Wednesday:
“Credit flows have been robust, particularly for businesses.
And as I said at the policy symposium in Jackson Hole, I would be hard-pressed to describe broad financial conditions as restrictive.
This view was widely shared by the Committee.
So, we removed a dose of accommodation.”
It’s worth noting that “Credit flows” – and “Credit” more generally – were last referenced at a post-meeting press conference back on September 26, 2020:
Powell:
“…over coming months we will continue to increase our holdings of Treasury securities and agency mortgage-backed securities at least at the current pace.
These asset purchases are intended to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”
“Credit” was mentioned 11 times in Powell’s press conference during the peak of the pandemic crisis - along with multiple “financial conditions”.
Trillions of QE ensured rapid Credit flow recovery.
Typical of the Fed’s deeply entrenched asymmetrical approach, discussion of “Credit” was MIA over the past five years of booming Credit.
And as financial conditions loosened to historic extremes, this important topic was similarly sidelined by Powell and Fed officials alike.
Warsh is resurrecting sound central bank principles – assembling the building blocks of a robust analytical framework.
“We aim to ensure that credit and financial conditions are consistent over time with our mandate, that relative price changes in some sectors of the economy do not broaden, that inflation compensation in market prices stays low, and that inflation expectations remain well-anchored.”
One (not) small sentence by the Chair, one giant leap for central bank monetary management.
Credit and financial conditions are now directly and explicitly associated with price and economic stability
“We removed a dose of accommodation, so that financial and credit conditions would be more consistent with our ultimate objectives.”
Another small sentence and big Regime Change leap.
Policy was accommodative.
Financial and Credit conditions were too loose.
A higher Fed policy rate is expected to tighten financial conditions, a necessary aftereffect to ensure inflation returns to target.
“So I’ll say three things, first is economic strength.
Part of the reason why we’ve seen over the course of 2026, long-term yields go up is the economy is strengthened.
Second reason, competition for capital.
The surge in capital expenditures… is real, and the so-called hyperscalers are out in the market raising funding, and so the competition for capital is real and I think it partly explains the increase in yields.
The third, is geopolitics.
The situation hot spots around the world are driving long-term yields.
It’s not simply spot prices of energy…”
Market savvy straight talk will take some getting used to.
Mention of the potential impact speculative deleveraging could have on U.S. and global yields would be asking too much.
Warsh’s hawkish tone was already sufficient to rattle markets.
Trading down to 4.60% before the Fed statement and Warsh press conference, two-year yields had spiked to 4.74% by Wednesday’s close.
Market expectations for the December policy rate rose eight bps to 4.21%, with the September 2027 implied rate surging 20 bps to 4.69%.
The VIX (equities volatility) Index jumped to a seven-week high of 19 during Warsh’s press conference (closed at 17.72).
After rising slightly on the release of the FOMC statement, the Nasdaq100 retreated 1.5% on Warsh’s comments.
High yield CDS rose from 308 to 317 bps (314 close).
The dollar index jumped three-quarters of a percent to a six-week high (100.25).
Markets had reason to fret Warsh – the hawk, regime changer and Trump defier.
Fretting was fleeting.
The Nasdaq100 advanced 1.7% in Thursday trading, with the Semiconductors surging 3.1%.
Intel jumped 7.7%, Micron 5.5%, and AMD 6.4%.
The VIX was back down to 15.42 by Thursday’s close.
High yield CDS ended Thursday trading at 306 bps, not far off eight-month lows.
What gives?
Warsh is more the determined hawk by the week.
He’s openly talking a new policy regime and has begun to raise rates specifically to tighten financial conditions, with today’s highly speculative and levered markets acutely vulnerable to tighter conditions.
“Today’s action starts to show we’re serious about this.”
The Fed is serious about returning inflation to target – and its Chair is channeling Paul Volcker.
Risk markets listen with keen interest – and yawn.
The rates market is pricing a 4.74% policy rate for year-end 2027 – essentially adding one additional rate increase (22bps) this week.
The policy rate was as high as 5.25% to 5.5% during the cycle peak between July 2023 and September 2024.
The yawns are explained by zero fear of Warsh “slamming on the brakes.”
Acute Bubble fragilities ensure the Fed will back down at the first sign of tightened conditions and market instability.
Warsh is earnestly pursuing major reforms and a new paradigm of Federal Reserve analysis and policymaking.
Instead of fearing inflation-fighting resolve and major uncertainties, risk markets confidently conclude it is business as usual in terms of liquidity support, bailouts, and Fed market “puts” more generally.
It’s not zero, but fear is muted that cautious rate increases will impact the flow of Credit.
Indeed, prevailing sources of current Credit growth are by their nature extraordinarily resilient.
The Treasury, the system Credit elephant, certainly won’t adjust its borrowing addiction based on Fed policy.
And 25 – or even 50 or 75 bps – will not temper the historic supply of AI-related borrowings.
Markets absorb incredible amounts of debt securities, while the banking system is now more eager to extend risky loans than even in 2007.
September 16 – Bloomberg (Paula Seligson, Preeti Singh and Michelle Cheng):
“A group of 10 banks is providing a $22 billion chip loan to support Blackstone Inc. and Alphabet Inc.’s new cloud venture Crux AI, the latest mega-debt deal in the race to finance the expensive processors crucial to artificial intelligence.
The debt will be used to purchase tensor processing units, or TPUs, a type of chip made by Google, and will be backed by the value of those chips and Crux AI’s customer contracts…”
Yahoo Finance’s Jennifer Schonberger:
“…Do you need to push growth below potential, unintentionally pushing weakness on the job market to bring inflation down, and how do those dynamics play out, given the forcefulness with which AI is driving the economy right now?”
Warsh:
“I don’t believe that we need to do harm to the labor markets to achieve our objective.
I don’t believe that the two parts of our mandate, price stability and full employment, are working at cross purposes over the medium term.”
Warsh, the principled central banker – the determined inflation-fighter; the smoothest of tough-talkers; the second coming of Volcker.
It’s all entertaining to an ebullient Wall Street that hears “do no harm” as if it’s blaring from a loudspeaker.
The MAG7 index traded intraday Friday above the May 28th all-time high (up 1.1% for the week).
The Nasdaq100’s almost 1% rise boosted y-t-d gains to 17.4%.
Advances pushed year-to-date gains for the Semiconductors (SOX) and Biotechs (BTK) to 68% and 31%.
The problem, as I see it, is a global bond market under increasing duress.
De-risking/deleveraging is gaining momentum.
Bonds need tighter financial conditions, waning inflationary pressures, and less supply of AI-related debt.
They’re past fed up with all the risk market fun and games.
Ten-year Treasury yields traded to 5.04% in Tuesday trading – the high since “still dancing” summer of ‘07 - closing the week at 5.00%.
Importantly, it was another Problem Children Week – “vigilante” stuff.
September 18 – Bloomberg (Alice Gledhill and William Horobin):
“A measure of French bond risk rose to one percentage point for the first time in 14 years, a sign of growing caution among investors given the country’s large budget deficit and ongoing political uncertainty.
The additional yield on French 10-year bonds over their German counterparts, which was already at its highest since 2012, rose to 103 bps Friday.
While the move came amid a broad selloff in European debt, the underperformance reflects long-standing investor concern over France.”
French yields jumped another 11 bps this week to 4.57% - up almost 100 bps in three months to the high back to September 2008.
Greek yields rose nine bps to 4.31%, and Italian yields gained eight bps to 4.34% - both to multi-year highs.
On news of a halt to BOE QT (bond liquidations), UK gilt yields sank from Tuesday’s 5.43% intraday high to 5.21% on Thursday – though yields were back on the march Friday to close the week at 5.30%.
It’s worth noting that Oracle (’36) bond yields (proxy for AI debt concerns) jumped nine bps this week to 6.97%, up 94 bps since the end of June.
CoreWeave (’32) yields surged 44 bps to 11.60%, up over 300 bps from June levels.
It was certainly not all clear sailing for this week’s notably bifurcated U.S. stock market.
The Banks were hammered 4.9%, with the Broker/Dealers slumping 3.3%.
The Utilities dropped 3.0%, and the Transports fell 2.7%.
I’ll also mention the past week’s $52 billion drop in money market fund assets.
Assets are essentially unchanged over the past five weeks, potentially marking an inflection point for a period of historic monetary inflation.
For now, it corroborates the thesis of an impactful deceleration in speculative leveraging (and liquidity creation).
With one eye on global “carry trade” leverage, currency markets are turning increasingly unstable.
The dollar/yen, trading at 153.40 in Monday trading, was above 158 early Friday.
Ominously, the yen lost 0.6% despite Friday’s BOJ rate increase, boosting losses for the week (vs. $) to 2.1%.
The MSCI EM Currency Index declined 0.86% this week, the “worst week since May.”
The South Korean won dropped 3.2%, the Colombian peso 3.0%, the Chilean peso 1.9%, the Polish zloty 1.9%, the Mexican peso 1.5%, and the Czech koruna 1.3%.
My base case has de-risking/deleveraging building momentum throughout global bond markets and the “carry trade” universe.
Seven weeks until midterms.
I’ll assume the administration would relish some type of Iran deal “October surprise.”
Probably positive surprises in the offing for the Trump/Xi talks.
Bessent’s batting average with the yen and Treasury yields is minor league material.
Desperately in need of a major bond market rally, the administration had better up its game.
The President at least demonstrated some restraint post-Warsh press conference.
September 18 – Bloomberg (Bernard Goyder):
“Around $7 trillion of US options notional value rolls off the books Friday, accounting for around a quarter of the market, according to… Citadel Securities.
The so-called ‘triple witching,’ where monthly S&P 500 Index options and single stock options all expire at the same time, is set to be the second-largest on record…
The expiry… creates a ‘potential reset in the market’s technical backdrop,’ wrote Citadel Securities’ market intelligence team, led by Scott Rubner.
‘As these positions expire or roll forward, the positioning that has helped dampen realized moves can change materially, potentially leaving the market more sensitive to underlying flows afterward.’”
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