Kevin Warsh’s second Fed meeting ended like his first one: No raising of the short-term interest rates – and corporate America worried about the consequences, On The Money has learned.
It’s not necessarily inflation per se that has CEOs worried, though that’s a concern. According to C-suite executives interviewed by On The Money, the major worry is about the slope of the so-called yield curve, which prices interest rates on short-term bonds to those on the 30-year Treasury.
Keeping the Fed Funds rate at its current level — a target of 3.50% to 3.75% — will impact short term rates, of course, but it does nothing to lower those longer-term interest rates that matter the most in the economy. In fact, it might steepen the yield curve more, and choke off the No. 1 driver of the economy, the artificial intelligence buildout.
That’s exactly what happened after Warsh’s stand-pat announcement. Yes, stocks sold off because he reiterated his fealty to the 2% inflation target, which seems hawkish. Bond traders are often more sophisticated in their analysis taking a longer term view of policy, and they were unimpressed, maybe a little worried. Yields on the 10-year and 30-year bond spiked.
Here’s something that most people even on Wall Street stock trading desks don’t appreciate: The Fed Funds rate doesn’t matter that much since it doesn’t directly impact most borrowing costs. It’s the so-called long end of curve – yields on the 10-year and 30-year bonds — where most CEOs, CFOs and other top corporate executives focus.
These are the interest rates that determine not only how much corporate bosses will pay to borrow in the market to expand their business, but also the price of most consumer loans including credit cards and mortgages.
And those interest rates have been rising (the 30-year is over 5% and the 10-year is heading that high). Some of it is related to inflation like higher oil prices amid the Iran conflict. But largely their spike, I am told, can be attributed to the AI build – hundreds of billions of dollars in bonds sold across corporate America that is pressuring rates on the long end.
It’s hard to put a cap on the AI buildout, at least for now, so dealing with inflation is something corporate executives want to see out of the Warsh Fed. And this is where the Fed Funds rate is important. A modestly higher uptick by Warsh will really show he’s an inflation hawk and it could help suppress the long-end of the curve, they tell me.
“If he wants long rates to go down he should be raising short term rates because the long end of the yield curve is more important than the Fed Funds rate,” said one CEO of a sizable financial-services firm. Because of the artificial intelligence buildout, “the demand for capital is insane and it’s lifting long rates higher.”
Thus a small raise in the Fed Funds might keep a lid on longer rates as investors see Warsh as being serious about inflation.
So why didn’t Warsh do what seems logical? The best guess from these C-suiters is that he doesn’t want to get into a pissing match with President Trump, at least until he gets settled at the Federal Reserve.
Indeed, Warsh is playing a difficult balancing act. Yes, he has long been known as an inflation hawk going back to his days as a Fed governor and later as a high-end investor and academic. He correctly predicted an inflation spike because of the loose monetary policy of his predecessors, Ben Bernanke, Janet Yellen and most recently Jerome Powell.
He also doesn’t want to get on the bad side of Trump, who is fixated with the Fed Funds rate as the end-all; it’s why he wanted Powell out as chair even before his term ended in May. Not even his Treasury Secretary Scott Bessent — who has repeatedly pushed the president to be more concerned with rates on the 10-year bond – could sway him.
OK, Trump won’t budge anytime soon. So maybe when the rise in the 10-and-30 year yield begins to choke off AI borrowing, possibly the only thing keeping the US economy out of a recession, he might – and allow Warsh to do what he knows he needs to do.