Kevin Warsh

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Colin Symons, CIO Lloyd Financial Group

A lot happened late last week. I’m going to write about the broader perspective on Monday. For now, I want to focus on the biggest financial news, the new Fed Chairman Kevin Warsh and interpretations of what he means for future monetary policy.

To review what happened at the FOMC meeting on Wednesday, half the FOMC Presidents submitted dot plots that said the Fed should raise rates at least once, lifting median expectations for rate hikes. This sharply lifted expectations of rate hikes, briefly sending 2Y Treasury yields to fresh highs.

The stock market tried to relax when Warsh spoke and indicated that he’s trying to walk away from a forward-expectation focus such as the dot plot and more towards a forward-looking, market-oriented approach. The bond market, however, would have none of that, and focused on the scary-looking dot plot.

From a broad perspective, the dot plot isn’t even that huge a change. The multiyear trend is still down. The point of tension for market is that the latest move in the front-end is a marginal increase in rate expectations. Additionally, to some extent I think this is market muscle memory in action. If we saw a scary dot plot in the Powell Fed, or anyone since Greenspan, for that matter, it would be cause for panic.

Again, Warsh is effectively attempting to end the long era of dependence on the use of forward guidance to guide the market. In his world, the dot plot doesn’t matter, which is why he didn’t give one. The emphasis with forward guidance was to guide the market through Fed actions, creating no surprises. Parenthetically, it also created a cottage industry of special-access journalists and private dinners.

Instead, Warsh hopes to improve Fed outcomes, in part with his task forces. Those task forces are supposed to review how the Fed works to strengthen their operations and credibility. He also wants the Fed to be more forward-looking, using better data, rather than stale backward-looking information. His ultimate goal is to use all this to create better price stability.

Great. What does all that actually mean for the market? It’s early days, still, so to some extent we have to speculate. I think the bond market was slow to react to the change Warsh is bringing, preferring to live in the past. The first move was panic, which at least failed to get worse on Thursday. I’d like to think that continues.

Along those lines, the market now predicts two rate hikes for the year, after they panicked on the dot plot. We only move forward, so the big question for the market now is if that’s the peak for short rates? Can we get to three hikes? I’d doubt it, but the forward path is what to look for. My somewhat aggressive bet is that we’re toying with a peak in hike expectations, here.

If rate expectations are peaking, that would imply rate stress is going to fade as a problem for the market. That would be great, as it’s been the primary issue for a while, with inflation fears from the Iran war keeping rate expectations elevated. At this point, I’d say the big concern is if Core CPI remains elevated, as that will keep rate expectations high. That’s a reasonable concern, as high oil can seep into other prices over time and settling all that may take time.

However, I think a Warsh-led Fed can see reality better than in the past. Based on his statements, he can clearly differentiate between supply and demand factors. Interest rate changes may work for changing demand levels, as it lowers or raises the expense of that desire. Rates do nothing for supply problems, like the Iran war hitting oil. Raising rates for supply issues doesn’t solve anything. They can’t magically create more oil.

Lastly, how seriously should we take the idea that the Fed will hike twice this year? I view that as signaling more than reality, though I admit the possibility of a hike is real. The market is taking past inflation and a scary dot plot and pricing that in, despite what I view as a sea change in how the Fed is likely to work under Warsh. Ultimately, I think it’s fair to say Warsh is attempting to bring change to an institution that I don’t believe has served the average American very well over the years. I hope he can do it.

Jobless Claims were 226K vs. est. 225K, with Continuing Claims 1810K vs. 1795K. Rising, but not to an alarming level.

More back and forth on Iran negotiations currently has stocks down marginally and oil down -3%, after a tense meeting ended with Iran citing major progress.

Stocks are likely down marginally more because rates have climbed a little more today, with the 2Y T yield up from 4.19% to 4.22%, as the bond market continues to panic over the Fed dot plot, such as BofA talking about three rate hikes, starting in September. I’ll take the under.

Conservative politician Espirella was elected as the new president of Columbia, sending their market (COLO) up 4%.

Fed President Waller will be talking today. Given the recent focus on the Fed, this may get more interest than usual.

Bottom line: Hysterics over the Fed are restraining an otherwise constructive market.

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