On Monday, we detailed the upward momentum in interest rates over the past month. This movement reflects the resurgence of inflation, widening deficits, and perhaps a new source of competition, as US Big Tech firms are now issuing debt to finance the development of AI.
The US 10-year yield is at its yearly highs, exceeding 4.6%, while the 30-year yield has reached its highest level since 2007.
However, in the coming weeks, another factor could further exacerbate this trend: a new Fed Chair. Indeed, Kevin Warsh will be sworn in Friday at the White House. Historically, his seven predecessors all saw rates rise in the three months following their appointment. The market tends to test the credibility of a new Fed Chair.
Evolution of short-term (2-year) and long-term (10-year) yields three months after a new Fed Chair takes office.
The market will be all the more inclined to test Kevin Warsh as his true convictions remain unclear. Will Chairman Warsh be the hawk who resigned from his position as Fed Governor in 2011? Or the dove who called for rate cuts during the race for the nomination?
During his tenure at the Fed (2006-2011), Kevin Warsh championed positions that labeled him a hawk. His opposition to the second round of quantitative easing implemented by the Fed ultimately led to his resignation.
However, in recent months, he has aligned himself with Donald Trump's calls for more aggressive rate cuts by the Fed. While this stance was clearly a prerequisite for securing the post, Warsh also holds a view of the US economy that justifies his alignment with the President. He believes that AI will trigger a productivity boom, leading to disinflationary growth similar to what the United States experienced in the 1990s.
This thesis might have held water at the beginning of the year, when the Fed anticipated a decline in inflation as the impact of tariffs was expected to gradually fade. Since then, the narrative has shifted completely. The war in Iran and surging energy prices have sent inflation trending upward again. Consequently, the debate has now shifted to: must the Fed raise rates?
What is certain is that markets remain a powerful corrective force. If a Fed Chair attempts to aggressively lower short-term rates, he will be penalized by a rise in long-term yields. This occurs because inflation expectations climb if the Fed appears to be abandoning its inflation target. To use a phrase frequently employed by Kevin Warsh in recent months: "inflation is a choice."
