JPMorgan, Apollo Urge Inflation Focus for Warsh's Big Speech
A chorus of investors is urging Federal Reserve Chairman Kevin Warsh to provide a strong rebuke of high inflation to boost the long end of the Treasury market.
Showing a clear commitment to price stability during his Friday speech in Jackson Hole may trigger buying of 30-year US government bonds. That would bring down yields that last week hit their highest level since 2007. Such a move would also aid Treasury Secretary Scott Bessent's mission to stop a selloff in long-duration debt and manage the country's ballooning interest burden.
Fed watchers at JPMorgan Chase & Co., Apollo Global Management Inc. and Morgan Stanley say Warsh has a chance to convince the market that managing inflation is his priority.
If he can, then “some of the angst on Fed credibility will reduce,” said Priya Misra, a portfolio manager at JPMorgan Investment Management.
That makes his Jackson Hole speech a pivotal early test for the Chairman, whose evasive communication style has baffled investors and raised doubts about how dedicated his central bank is to controlling price growth. US inflation has floated above the Fed's 2% target for the past five years and 30-year Treasury yields have sat above the key 5% level for the last two months despite Bessent's interventions, which include a plan to buy back long bonds. Persistently high borrowing costs have weighed on the US housing market, private equity firms and small businesses alike.
The US 30-year yield was little changed at 5.19% in early Friday trade after rising as high as 5.34% last week.
Misra said a clear condemnation of high inflation from Warsh would result in lower term premium, a measure of how much extra compensation investors demand to shoulder the risk of owning longer-term US debt. A closely followed New York Fed gauge is trading near levels last seen in 2014.
“If the Fed is focused on inflation, term premium should get crushed because now the Fed is a lot more credible,” said Vishal Khanduja, head of broad markets fixed income at Morgan Stanley Investment Management.
Market participants will scrutinize every word from Warsh at the Fed's annual gathering in Wyoming. In his press conference following the central bank's July meeting, he refused to explain how policymakers might react to different economic outcomes. One remark led some to think that the Fed's inflation target could be altered in January, creating more uncertainty and sparking a selloff in long-end Treasuries.
If Warsh walks back some of those comments on Friday, “this would likely bearishly flatten the Treasury curve,” which happens when short-term rates rise faster than long-term ones, according to Jay Barry, JPMorgan's head of global rates strategy.
“He will have to deliver something that is clearer than the July press conference,” Torsten Slok, chief economist at Apollo Global Management, said in a Bloomberg Television interview. While Warsh doesn't need to telegraph the Fed's next move on interest rates, Slok said the Chairman should offer his view on the state of inflation and the job market to make his priorities clear.
“If he does not give any framework guidance, the risk is that that it will involve a much higher move in long rates,” Slok said.
What Bloomberg strategists say...
“It feels like things will come down to payrolls and CPI to determine conviction on September's FOMC decision, assuming that Kevin Warsh doesn't break form and provide some guidance from Jackson Hole.”
— Cameron Crise, Bloomberg Markets Live strategist.
Investors see a number of reasons for high yields across the Treasury curve. The long end is plagued by record-high US debt that just surpassed $40 trillion; sticky inflation is keeping the front end elevated; and in the so-called belly, a flood of borrowing from artificial intelligence giants is creating upward pressure, Slok said.
“The whole yield curve is at risk of moving higher,” he added.
Warsh's speech is also an opportunity for share a macroeconomic outlook ahead of the August jobs report next week and consumer price index data that will land just days before the Fed's next policy decision on Sept. 16. The market is currently pricing a roughly 35% chance of a quarter-point rate increase next month.
“The final arbiter is still the data and that's what the market will look for once Warsh speaks,” said Kevin Flanagan, head of investment strategy at WisdomTree.
“The two-year still trades above fed funds and that reflects some uncertainty premium around Warsh, and a market that has not eliminated the possibility of a rate hike even after the softening in the July data for jobs and inflation,” he said.
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