The Bond Market Doesn’t Like Bullshit

Why Kevin Warsh just bombed

CNBC

The Federal Open Market Committee of the Federal Reserve meets every six weeks to set interest rates — specifically the federal funds rate, the overnight rate at which banks lend each other money. The Fed funds rate has little direct economic significance, since nobody making important investments relies on overnight money. But an upward or downward change in the Fed funds rate tends to drag longer-term rates up or down with it. Even more important, FOMC decisions, along with their public statements, affect the market’s expectations about future monetary policy.

Setting such expectations is one of the major roles of the Fed. So FOMC decision days are something of a theatrical performance. The committee doesn’t just announce its interest rate decision. It releases a statement explaining that decision; then the Fed chair holds a press conference, in which he or she tries to build credibility by answering reporters’ questions. Market traders closely analyze these statements in order to predict the future direction of inflation and monetary policy. As a result, FOMC decisions and statements have critical influence over current market rates.

On Wednesday Kevin Warsh, who Donald Trump selected as Fed chair, played the starring role. His job was to explain why the Fed didn’t raise rates in the face of inflation that is persistently well above its 2 percent target.

By all accounts he bombed. In particular, the bond market, the ultimate reviewer, really didn’t like Warsh’s performance. As the chart at the top of this post shows, the 30-year Treasury rate spiked and the dollar fell slightly. In plain English, this was the equivalent of bond market traders running for the exits.

A little background is in order to understand exactly what happened here. At 3.7%, inflation has been persistently well over the Fed’s 2% target rate — largely as a consequence of Trump’s tariffs, which have raised the prices of imports, and his Iran war, which has caused energy prices to soar. The Fed normally raises interest rates to fight inflation. But it instead left rates on hold in this meeting.

The truth is that the case for an immediate rate hike was somewhat iffy. When a spike in inflation is temporary and will soon fade away from its own accord, the Fed tries to “look through” this temporary shock and not base interest rate decisions on it. Both the Trump tariffs and the energy price spikes are arguably one-time events. But whether the inflation shock is truly transitory is not certain. Thus three of the FOMC’s 12 members dissented and called for a small rate hike. And it’s important to note that three dissents is a lot. This was the first time since 1970 that a new Fed chair faced three opponents to an early interest rate decision. Yet Wednesday’s decision not to increase the federal funds rate was widely expected, and shouldn’t have rattled markets.

But the bond market was indeed rattled. Its reaction indicated that traders believe that there is a good chance that the Fed is going to keep rates too low for too long and thereby feed inflation. As a result, the Fed will eventually be forced to raise future rates to a higher level than if it acted to rein in inflation now.

So it’s clear that the bond market reaction wasn’t a judgment on the rate decision itself. It was, instead, a judgment on Warsh. In other words, Warsh’s remarks on Wednesday led the market to distrust his commitment to fighting inflation.

When Trump selected Warsh, I noted that Warsh had been completely wrong about monetary policy in the aftermath of the financial crisis. He called for rate hikes, which was the exactly wrong policy for a deeply depressed economy. He warned about inflation; when the inflation didn’t materialize, he just came up with new arguments for the same policies. I didn’t mince words about the consequences of choosing Warsh as Fed chair:

Many media reports are describing Warsh as a monetary hawk. That’s a category error. Warsh is a political animal. He calls for tight money and opposes any attempt to boost the economy when Democrats hold the White House. Like all Trumpers, he has been all for lower interest rates since November 2024.

As I pointed out at the time, other independent economists had similar things to say. So how did he end up at the top of the Fed? As I noted,

[Warsh is] an effective bullshitter. Sorry for the technical language, but I can’t find another way to say it. Listen to Warsh on economic policy, and he throws around a lot of big words that presumably sound impressive to people who don’t know anything about the subject. But there’s no coherent argument behind the verbiage.

What Warsh really needed to do in his press conference was refute the critics and show that he was more than a partisan who got the job in part because Trump thinks he looks the part. He failed.

Warsh didn’t necessarily need to advocate a rate hike. But he has harshly denounced the Fed for acting too slowly to tame inflation in the Biden years. Now he finds himself in a superficially similar situation, so at the very least he needed to explain clearly why he thinks this time is different. Instead, his performance at the press conference was stumbling, confusing, and evasive. At times he seemed to suggest that the Fed doesn’t need to do anything to control inflation, a total contradiction of his previous critiques.

Scattered reports also suggest that Warsh is failing to gain the respect of his colleagues at the Fed. Three dissents is, as I said, a lot. One Fed governor, Chris Waller, mocked Warsh’s plans to set up multiple task forces to study key issues. According to the Wall Street Journal,

What’s the point of all this, [Waller] asked. Tell me who you’re putting on these groups, he said, and I’ll tell you what they’ll say. There were no brilliant ideas out there that everyone had somehow missed.

And Lorie Logan, the president of the Dallas Fed, made a point of concluding a recent speech by reminding the audience that

Neither I nor any other single person makes monetary policy on their own in the United States. The Federal Open Market Committee is a committee.

Whatever she meant by that, the audience surely heard it as saying, “Don’t worry, Warsh isn’t really in charge.” That’s reassuring if one doesn’t trust his judgment, but it also means that he won’t be an effective leader if we face an economic crisis.

Now, Warsh isn’t Trump’s worst appointment, by a long shot. Even among the economic appointments, he’s nowhere near the depths of corrupt sycophancy plumbed by Scott Bessent, the Treasury secretary, and Howard Lutnick, the Commerce secretary.

But the markets were looking for some sign that Warsh isn’t the lightweight bullshitter he appears to be. What they got instead was evidence that Warsh is no better than he seems. And let’s hope to God we don’t have another economic crisis while he is at the helm.

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