Federal Reserve Chair Kevin Warsh can tighten monetary policy without a formal rate hike, using two nontraditional levers instead. Both are already reshaping bond yields after a historic three-way dissent at the Fed's July meeting.
Federal Reserve Chair Kevin Warsh doesn't need to raise the federal funds rate to push borrowing costs higher – two nontraditional levers are already doing that work. The Federal Open Market Committee held its benchmark rate steady at 3.5%-3.75% at its July 28-29 meeting, even as three policymakers dissented in favor of a quarter-point rate hike, marking the first time in 56 years that three FOMC members dissented so early in a new chair's tenure.
The split highlights how hot inflation has run this year. Consumer prices hit a three-year high of 4.2% in May and 3.5% in June. The dissent also rattled stocks, with the Dow Jones Industrial Average dropping 0.11%, the S&P 500 falling 0.06%, and the Nasdaq Composite sliding 0.32%.
Dropping forward guidance is already moving yields
Warsh scrapped forward-looking guidance from FOMC meeting statements starting with his first meeting as Fed chair in June, ending a practice the central bank had followed for more than two decades. According to The Kobeissi Letter: "Forward guidance is not the business we should be in", Warsh said in announcing the change.
Removing that guidance is likely to make bond traders more cautious whenever inflation drifts far from the Fed's 2% target. As a result, the 30-year Treasury yield climbed to a 19-year high, with the 10-year yield close behind. Higher long-term yields raise borrowing costs much the way a traditional rate hike would.
Shrinking the balance sheet is the second lever
Warsh also wants the Fed to pare down its balance sheet, which he criticized during testimony before the Senate Banking Committee on April 21 for growing tenfold between August 2008 and March 2022, to nearly $9 trillion. The Fed held $6.75 trillion in assets as of Aug. 5, mostly long-term Treasurys and mortgage-backed securities.
Because bond prices and yields move in opposite directions, selling off that portfolio would push long-term yields higher and make lending costlier. But unlike the guidance change, deleveraging the balance sheet needs backing from Warsh's FOMC colleagues before it can happen.
Source: The Motley Fool
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