Fed’s Warsh’s credibility in question after rate decision: Analysis

For a Federal Reserve chairman who prizes credibility above all other virtues, the market’s reaction to Kevin Warsh’s remarks Wednesday must have been painful. 

Warsh hosted a press conference Wednesday afternoon following a meeting of the Federal Open Market Committee, which voted 9-3 to leave interest rates unchanged. It was just the second such meeting since Warsh became head of the Fed on May 22. Investors responded by sharply lowering the chances that the Fed will raise interest rates at its next meeting but also raised the yields on long-term government debt. 

After the press conference, the yield on the 30-year Treasury hit its highest level since 2007, while the yield on the 2-year Treasury fell. The chances that the Fed would leave interest rates unchanged at its next meeting jumped by 20 percentage points to 45%, according to CME FedWatch.

That dynamic suggests investors believe the Fed won’t act immediately on inflation readings that by Warsh’s account have been above the Fed’s 2% target for at least 63 months, and that it may have to act on more aggressively later as the economy heats up for the long haul. 

Before taking the job, Warsh sharply criticized his predecessor Jerome Powell when long-term Treasury interest rates moved up after the Fed cut the federal funds rate and said repeatedly that the underlying problem was Powell’s lack of credibility. The situation Wednesday was slightly different, in that the Fed didn’t cut interest rates but held them steady. Warsh also suggested Wednesday that recent rises in long-term interest rates may have reflected positive economic news, such as strong business investment. 

Still, few in the markets saw it that way.

Warsh needed to articulate what it would take for him to want to eventually raise interest rates in the face of stubborn inflation, Jon Hilsenrath, a longtime Fed watcher, wrote in a note to clients after Warsh’s press conference. 

“Warsh didn’t convey the message clearly or explicitly, and the bond market puked on him,” Hilsenrath wrote.

Warsh declined to answer reporters’ questions about the details of why he, along with eight others on the FOMC, deemed the interest rate was in the right place at 3.5-3.75%, where it has been for months. Warsh has shifted Fed policy by ending a practice known as forward guidance. Past Fed chairs would strongly signal where they expected interest rates to go in the future. Warsh believes forward guidance made the Fed inflexible and obscured signals from the markets. As a result, he doesn’t talk much about how he makes decisions. 

“I understand the desire for rolling forecasts and commentary from this committee, but for our part, we need to observe market reaction to developments,…