New York (CNN) — Federal Reserve Chairman Kevin Warsh repeatedly said Wednesday that the central bank is committed to reining in inflation.
“Let me reiterate: There is no soft inflation target,” Warsh said in remarks after the Fed’s highly anticipated meeting. “There is no soft implicit target, not on this committee’s watch. There’s only a target, and it’s 2%.”
The bond market called his bluff with a message back: Show us you mean it.
Long-term bond yields surged during Warsh’s remarks, with the 30-year US Treasury yield jumping from around 5.1% to 5.21%, its highest level since 2007. The 10-year yield jumped from just above 4.61% to almost 4.69%, nearing its highest level in over a year.
Long-term yields move on expectations for inflation and economic growth. The surge in yields signals traders are concerned that the Fed might not do enough to rein in stubborn inflation.
Meanwhile, the short-term two-year US Treasury yield, which tracks expectations for Fed policy, dipped lower and was relatively unchanged.
Traders in recent months have raised bets on the Fed hiking rates this year to combat inflation, and the rise in the 10-year yield can also reflect rate-hike anticipation. But the size of the move in the 10-year and 30-year yields signals nerves about inflation.
Yields rise when bond prices fall. Traders dumped long-term bonds, demanding more compensation for the risk of inflation eating into their return.
“Really the market’s issue is, are you doing something?” Steve Sosnick, chief strategist at Interactive Brokers, told CNN after Warsh’s comments. “It’s one thing to talk about fighting inflation. It’s another thing entirely to do something about it. And again, it’s not clear what he’s doing about it.”
The Fed on Wednesday held interest rates steady for the fifth meeting in a row.
The US-Israeli war with Iran and the ensuing oil shock in recent months have boosted inflation. Resurgent tensions this month have reawakened fears about a prolonged period of higher oil prices.
That’s also an issue for the Fed because its tools largely focus on demand; supply shocks like tightening global oil flows or memory chip shortages from the AI boom are much harder to address with monetary policy tools like interest rates.
The Fed chairman has assigned task forces to review different topics including the central bank’s approach to inflation. While Warsh has been outspoken about his insistence on taming inflation, markets are growing impatient.
The heightened volatility in the bond market also comes as Warsh has signaled interest in less messaging and forward guidance from the central bank. Warsh said on Wednesday that he’d prefer for markets to “play the ball” as opposed to “the referee.”
“I was comforted that markets in the inter-meeting period weren’t reacting to us. They weren’t reacting to (the Fed’s quarterly dot plot) or to speeches,” he said. “They appeared more than ever to be reacting to real-time events, so they’re gauging themselves how restrictive the Treasury curve should be, and that I think has been a useful development.”
Stocks, bonds and the US dollar all fell as Warsh’s remarks stirred up volatility. The Dow fell more than 1,100 points, or 2.19%, for its worst day in over a year. The dollar index fell more than 0.5% as traders adjusted bets on when the Fed might hike interest rates.
Markets are pricing in a 57% chance the Fed raises interest rates in September, according to CME FedWatch, a real-time forecasting tool. This is down from almost 70% earlier this afternoon, though roughly in line with yesterday’s odds.
Bond yields have climbed this month as tensions between Washington and Tehran have picked up and oil prices have rebounded higher. Warsh on Wednesday acknowledged the rise in yields but said he welcomed the market adjusting to data on its own. Still, higher yields – and the bond market – will test Warsh’s outlook.
The 10-year US Treasury yield influences borrowing costs across the economy, including mortgage rates. Higher yields mean tighter financial conditions. The 30-year fixed mortgage rate last week rose to 6.58%, its highest level in almost a year.
Three Fed members dissented on Wednesday in favor of a rate hike, showing some divide within the central bank. The surge in yields is also one sign that the markets are testing the new Fed chair.
“It’s not uncommon for markets to test new Fed chairs,” Sosnick said. “You don’t really know how the market’s going to react.”
“The market mood in the last few weeks has changed from sanguine about everything to a bit more cautious and a bit more nervous and a bit more ‘show me’ (action on inflation), and we’re not getting that right now,” he said.
Stocks were also under pressure from weakness in tech and AI stocks. The Nasdaq Composite is down 9.8% from its peak in early June, putting the index on the brink of a correction (a fall of 10% from a recent peak).
“In Warsh’s press conference, he once again failed to specify how he intended to achieve his stridently asserted inflation resolve,” Michael Feroli, chief US economist at JPMorgan Chase, said in a note.
Feroli said he now expects the Fed to hike interest rates in December, compared to his previous forecast of the second half of 2027.
“We wouldn’t characterize this revision as the market ‘pressuring’ the Fed, but rather another challenge prompting the Fed to act to maintain its credibility,” Feroli said.
Christian Hoffmann, head of fixed income at Thornburg Investment Management, said he thinks the rise in long-term yields reflect a market that is “openly questioning” Warsh’s credibility.
“Credibility is much easier to lose than it is to gain,” Hoffmann said in a note. “It is difficult to view today’s outcome as anything other than an own goal.”
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