The New Fed Chair

I went out to dinner Friday night when I got a text from one of my old Wall Street buddies. Apparently, Fed Chairman Kevin Warsh announced that he would try to reduce the number of FOMC meetings every year. Currently, there are eight. Maybe he would go to six? Or four?

This is kind of like Trump’s desire to go from quarterly reporting to semiannual reporting for publicly traded companies, something else I agree with. I have a friend who is a CEO of a pretty big company, and he says he spends about two-thirds of his time prepping for earnings and not actually running the business. It is a huge administrative burden, and there is anecdotal evidence that investors would be better served with less, rather than more, information.

Warsh simply wants to reduce the Fed’s role in the setting of monetary policy—he wants to let the market do it. He wants the Fed to do and say less. Which is a very libertarian approach! I think the market does a better job of conducting monetary policy than a bunch of unelected bureaucrats.

Buy the Dip in Bonds

The market is having a tough time adjusting to this idea, and the bond market is revolting (double entendre there), with 30-year yields up near 5.30% in recent days, the highest since 2007. People are interpreting this as a crisis of confidence with the Fed, but it’s really not. This is all by design—Warsh declined to raise rates and is letting the bond market do the tightening for him. And the bond market will be much more effective at tightening than the Fed will—it will have an instantaneous effect. You get mortgage rates up near 7%, that is certainly going to slow down the economy. 

If Warsh had hiked Fed funds, the yield curve would have actually flattened, easing financial conditions. It’s a genius move. It’s also genius because Trump doesn’t understand the nuance and is simply happy that Warsh didn’t raise rates. The danger here is the bond market will utterly collapse, and things are looking pretty tenuous right now, but I think we are much closer to the highs in yields than the lows. Also, people like to buy the dip in stocks, but nobody likes to buy the dip in bonds. I suggest you buy the dip in bonds.

Anyway, Warsh is lucky… and shrewd. Harvard and Stanford on his CV, married a billionaire heiress, pals around with Stan Druckenmiller, improbably was selected to serve as a Fed Governor in 2006, and soothed the Trump savage beast to get the top job at the Fed. My guess is that Fed Chairman is simply a stepping stone for him—he wants to run for president. 

Well, we could certainly do worse. But in the interim, he has to get inflation under control. He seems to be the only person at the Fed who understands what a yield curve is. The old Fed thinking was that raising Fed funds would raise rates across the curve, tightening financial conditions in a trickle-down effect. That typically isn’t what happens, which means that most Fed thinking has been counterproductive over the last 10–15 years. Warsh gets it. And the market is not adjusting well.

Yield Curve Control

I have seen a few comments on Twitter about yield curve control since the last meeting. The idea behind yield curve control is that long-term rates will rise to the point where they will choke off economic activity, and the Fed will ride to the rescue and peg long-term yields, printing money to buy an unlimited amount of bonds in the process. 

That might happen someday. We are a long way away, but it probably will happen, given where the deficit is and the trend of where it is going. This is a good reason to hang on to your gold, and that is all I have to say about that. Warsh, not being a big fan of the Fed balance sheet, is probably not going to act to expanding it further. But if we get desperate times, it will call for desperate measures. Maybe if there is a new Fed Chairman after 2028. I’m sure the Democrats will have different, un-libertarian ideas about monetary policy.

I like Warsh, even if he is murdering my portfolio. I say “murdering” because I own a lot of bonds these days, and every day with him in charge of the Fed is a new adventure. From a trading standpoint, I don’t think bond yields get to 6%. They might go higher, as they recently broke out above resistance, but probably not by much. The yields are pretty tasty here. Really, anything over 5% looks like a good deal to me. 

If you closed your eyes and woke up in a year, you’d probably find that bond yields were materially lower. The AI trade just bounced, but it is probably doomed, and private credit is doomed, and people are taking more risk than at any point in history. Bonds usually go up during recessions, and that is all I have to say about that.

Jared Dillian, MFA