Treasuries Hover Around 4.7% As Wall Street Questions If Warsh Is A 'Dove In Hawk's Clothing'

Treasury yields are grinding higher again in the wake of this week's meeting of the Federal Open Market Committee, which held interest rates flat for the fifth meeting in a row.

In addition to that vote, comments from new Federal Reserve Chair Kevin Warsh around the meeting spooked investors, leaving them questioning whether the Fed could adequately tame inflation.

Bonds rose in real time as Warsh delivered a press conference that suggested he could be a “dove in hawk’s clothing,” as Evercore ISI analysts put it in a note after the call. 

Yields on 10-year Treasury notes edged up 4 basis points between the time the Fed released its decision and when markets closed Wedesday. They flirted with 4.75% Friday, well above the 4.5% that many in the world of commercial real estate had pegged as the ceiling for potential trouble on debt from the days of ultra-low interest rates.

"We think that the bond market is not mainly responding to the July decision, but rather to the uncertainty regarding the strategy the Fed chair intends to follow to deliver price stability," wrote Krishna Guha, head of central banking strategy and economics for Evercore ISI.

For investors, the complaints seem to boil down to questions over whether Warsh and the rest of the FOMC have the wherewithal to raise rates in the face of stubbornly high inflation on one side and intense political pressure on the other to loosen monetary policy. 

"He only talked about the inflation target itself, without saying that we're ready to take action. Markets didn't like that," former St. Louis Fed President James Bullard said in an interview on Bloomberg TV. 

Warsh rolled out five task forces at his first meeting last month that he said are examining every aspect of how the central bank tracks the economy, considers policy and makes decisions. 

He also discussed the possibility of reducing the frequency of FOMC meetings during Wednesday's gathering, The New York Times reported Friday, citing anonymous sources.

J.P. Morgan Chief Economist Michael Feroli took a more pessimistic view following the meeting. 

"These comments seem to confirm suspicions that the task forces are just covers to redefine the inflation challenge away," Feroli said, according to Yahoo Finance. "Both of these points raise questions about the new chair's credibility in delivering lower inflation. We believe this will add some urgency for the rest of the committee to act on its mandate."

If the Fed loses credibility on inflation, it is likely to further drive up longer-dated Treasury yields as investors demand more compensation for the price hikes, which directly impacts rates on all types of commercial real estate debt. 

In May, investors debated whether a 10-year yielding north of 4.5% would lead to a wave of debt issues that haven’t yet come to fruition, but loan workouts take time, and the drumbeat of higher Treasuries only increases borrowing costs further.

CMBS delinquencies ticked up 51 basis points to 7.86% in July, led by a group of very large loans that were moved to nonperforming status, according to Trepp. The upward momentum marked a significant shift from what had been a relatively stable prior 12 months  

The Fed has long said its target for inflation is 2% — a point Warsh reiterated more than once after Wednesday’s vote — but it has for years struggled to get there. The long tail of pandemic-era inflation gave way to tariff-driven price hikes, and now the U.S. war with Iran is driving up energy prices and the price of everyday goods along with it. 

The core personal consumption expenditures price index, the Fed’s preferred inflation metric that excludes volatile food and energy costs, sat at 3.4% in May, the most recent data available when the Fed decision was announced.

But updated figures for June, published the day after the Fed meeting, showed that core PCE was up 3.3% that month, with prices up a more modest 0.1% month-over-month than the faster clip of price growth that the economy had been experiencing. 

Warsh seemed to be trying to avoid saying the Fed was waiting for the upcoming inflation data, and another inflation read before the central bank's next meeting, before making a decision. Investors viewed the lack of candor as potentially showing less of a commitment to fighting inflation than many had expected. 

"Ironically, we think the need to re-establish credibility increases the probability that the Fed will hike in September, all else being equal," Bank of America economist Aditya Bhave wrote in a memo after the decision.  

The FOMC dissenters in the 9-3 vote to hold interest rates flat all focused on inflation in statements or interviews explaining their perspective after the vote. 

"In my view, now is the time for the FOMC to act to speed the return of PCE inflation to our 2 percent objective and deliver on our commitment to price stability for the American people," Federal Reserve Bank of Cleveland President Beth Hammack said in a statement. "The longer that high inflation persists, the more challenging and costly it can be to bring it back down."

Minneapolis Fed President Neel Kashkari and Dallas Fed President Lorie Logan also dissented in favor of a quarter-point hike, with Kashkari warning in a statement that waiting risked faster rate movement in the future. 

"If inflation remains elevated, a potential series of small policy moves would be better than waiting and eventually concluding that even bolder actions weren't necessary," he said.