Federal Reserve Chairman Kevin Warsh keeps promising to fight inflation but won't say how, and Citadel Securities says that vagueness is generating uncertainty for investors. Long-term Treasuries sold off after the Fed's latest hold, dragging the dollar and stocks lower, and Citadel warns the setup risks a negative feedback loop between yields and policy.
Kevin Warsh is generating uncertainty for investors, according to Citadel Securities: he keeps committing to control inflation without detailing his approach. He has said repeatedly that the Fed must tackle consumer-price increases that have surpassed its target for five straight years. Even so, the Fed held rates last week, with three policymakers backing an immediate increase.
Treasury Yields Are Doing the Fed's Work, Warsh Says
Warsh argues the market is doing some of the Fed's work for it: he said the recent climb in Treasury yields has already tightened financial conditions, and floated reconsidering whether the Fed's current preferred inflation gauge should stay the benchmark once its policy framework review concludes.
Investors sold long-term Treasuries after the decision, which raised inflation expectations and pulled down both the dollar and stocks. Nohshad Shah, Citadel's head of EMEA fixed-income sales, said the reaction called into question how credible and clear the Fed's framework really is.
Citadel Warns of a Feedback Loop
Shah warned that leaning on markets to do the tightening risks a feedback loop: higher long-term borrowing costs could push the Fed to delay rate increases, which would likely lead investors to demand bigger inflation and term premiums, driving yields even higher. According to Shah: "The Fed holds because markets have tightened, while markets tighten because the Fed has held."
Not every yield move carries the same weight, he added. Short-term rates rising on Fed-tightening expectations restrain demand, but long-term yields climbing because investors want more compensation for inflation and policy uncertainty could erode confidence in the Fed's commitment to price stability.
Source: Economy News
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