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The Macro Brief - The Fed under new management
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As the Federal Reserve begins a new era with Kevin Warsh at the helm, our team looks at his communication style and how the narrative has changed from potential rate cuts to possible rate hikes.
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Transcript
Introduction to the Macro Brief Podcast
00:00:09
Speaker
Hello, I'm Aline Van Dyne in New York and welcome to the Macro Brief from HSBC Global Investment Research, the podcast that looks at the issues driving financial markets.
Impact of New Federal Reserve Management
00:00:21
Speaker
Now, today we're looking at one of the biggest changes for global financial markets, new management at the US Federal Reserve, the world's most influential central bank.
00:00:32
Speaker
Kevin Walsh held his first meeting this week as chair of the FOMC, where U.S. policymakers decided to keep rates steady. But a lot more happened and a lot is at stake, not least given concerns about political pressure on Mr. Walsh to lower rates, So a new chair who wants to change things and a U.S. economy that is robust with inflation still elevated. Let's get into what this all means for the U.S. and beyond.
00:01:00
Speaker
I'm joined by Ryan Wang, our U.S. economist. Great to be here.
Panelists Introduction
00:01:04
Speaker
Deiraj Narula, our US rate strategist. Good morning. And our special guest, Fred Newman, who's our chief Asia economist and also host of our sister podcast, Under the Banyan Tree. Fred, welcome. And ah you're going to be answering some questions this time, not just asking them. Thank you. Wonderful to be here in New York in the studio. First time.
00:01:26
Speaker
Great. Great. Welcome. Now, Ryan, let's start with what actually happened at the FOMC.
First FOMC Meeting Under Kevin Walsh
00:01:32
Speaker
What's going on in terms of interest rates? Yeah, it was the first FOMC meeting under the new Fed chair, Kevin Warsh, and there was a new communication style. We saw that in the form of a much shorter, much more direct policy statement.
00:01:45
Speaker
And Kevin Warsh had previously expressed some reservations about the specific forward guidance that the Fed has been providing in the form of – The famous DOTS projections, the economic projections for the next several years. and This was kind of interesting because actually the Fed did continue to publish those projections. But Kevin Worsh individually refrained from submitting his own views about the economy and where policy rates should be headed. So it was a little bit confusing in that sense, but markets did react to the rate projections, which have changed substantially since earlier this year. The markets and the Fed were thinking about rate cuts. Now the question is all about possible rate
Market Reaction to FOMC Meeting
00:02:23
Speaker
hikes. And we saw a divided committee with basically half of the FOMC thinking that rate hikes might be appropriate later this year.
00:02:30
Speaker
Dheeraj, what was the market reaction? So the market clearly took this as a hawkish Fed meeting. And I would say there's two reasons for that. The first, as Ryan pointed out, was that the dots that were submitted indicated that nine out of 18 policymakers submitting a dot plot were looking for rate hikes this year, including six that were looking for multiple rate hikes. That went pretty much significantly more hawkish than most investors were expecting. The second reason for kind of this hawkish move and the upwards ah increase in front-end rates was the focus placed on inflation. So the policy statement itself, while much shorter than the previous one, referred to the price stability mandate in the in a very decisive way, saying the committee will deliver price stability. In contrast, the references to the job market kind of only pointed out stability in the unemployment rate. So clearly this was very attuned towards the inflation side of
Fed's Role in Inflation Management
00:03:22
Speaker
the Fed's mandate. So this is important. Does this suggest, Ryan, that Kevin Walsh is indeed fairly hawkish?
00:03:30
Speaker
Well, it was clear that Chair Warsh emphasized many times that the Fed has responsibility for inflation. And this also was really the final line of the policy statement that the Fed will deliver price stability. Now, the question is, will that actually require rate hikes later this year?
US Rate Hikes and Asian Economies
00:03:49
Speaker
We have long been forecasting that the Fed would not make any changes to the Fed funds rate. which of course was left unchanged at the latest meeting and and is sitting in this range between 3.5% and 3.75%. And it also has to do with the evolving risks to inflation.
00:04:05
Speaker
Of course, there's been a big energy price shock in recent months, but there is some prospect that energy prices might ease up a little bit depending on what we see with respect to the the situation in the Middle East.
00:04:18
Speaker
So Fred, is the potential for rate hikes in the US, which you know is not our base case, but would a shift in that direction have an impact on Asian economies, for example?
00:04:31
Speaker
Yeah, of course. you know Asian central bankers are watching the Fed just like all of us do, and it's very important for the region. Now, what's interesting here is that we've just seen a kind of easing of oil prices. So the fear that higher energy prices will drive inflation the second half have kind of you know calmed down a little bit. And so you think, OK, then central banks don't need to be hawkish. They can maybe relax a little bit.
Task Forces and Fed Communication Strategies
00:04:57
Speaker
But ah central banks in Asia also are kind of beholden to the Fed. So if we do get the markets pricing in more Fed hikes, that could mean a stronger dollar.
00:05:08
Speaker
And that means depreciation pressure on local currencies in Asia. And then central banks need to tighten monetary policy because weaker currencies in Asia themselves can be inflationary. So think of the Bank of Japan. um they, you know, the yen is weakening. If the dollar is strengthening, then you still have an argument for tightening. So we had a brief respite here, few days when the energy price were down, people thought, oh, maybe there might be no need for Asian hikes. And now we've got Ms. Chair Walsh coming through, very hawkish, and hikes are back on the table.
00:05:40
Speaker
So hikes are back on the table, but beyond the interest rate picture, there's a lot of other potential changes. Five task forces, I believe, Yeah, absolutely. So we had a taste, as I mentioned, about the new communication style under the Warsh-led Fed. And and that's the really the subject of the first of five task forces, Fed Communications. But there is four other task forces that are expected to deliver deliver results, some sort of results by the end of this year, according to Mr. Warsh.
00:06:10
Speaker
And those relate to the balance sheet and also to the economic data sources that the Fed uses to make its decisions. to the big theme about productivity and the labor market in the context of an AI economy. And finally, just how the Fed should manage inflation in the first place. It's inflation framework, so to speak. So I don't think any of these frameworks, reviews or or task forces are going to necessarily deliver immediate changes to how the Fed does its business with you know with the exception of the communication style, which I think has already clearly evolved.
Bond Market Response to Fed's Inflation Focus
00:06:41
Speaker
um But these are all major issues. And importantly, that that fourth task force is is is a critical question.
00:06:47
Speaker
How is the U.S. economy really going to evolve in the next few years with these significant technological changes? Yeah, and I think it's interesting to see more broadly how the bond market has reacted to kind of both the near-term view that there is clearly a focus on bringing price stability about. But if you look at the long end of the Treasury curve and where long-end rates have set, they've actually ticked down in the aftermath of the meeting. And I think that's a very clear message that the bond market... believes in this credibility of inflation fighting. It kind of believes that the Fed will ultimately deliver a policy setting that's credible, that's targeted towards its mandates. And in fact, despite greater perhaps uncertainty about what any individual meeting outcome might be, the overall trajectory of rates is kind of something the market has more confidence in.
Market Volatility and Inflation Measurement
00:07:32
Speaker
But what about volatility, though? All this uncertainty task forces, is there increased volatility in the markets? I would say yes, especially in terms of the individual meetings and the very front end of the Treasury curve. So we've kind of gotten used to a regime where bond markets were fully pricing in the outcome of every single Fed meeting ahead of time to the point where any decision that deviates from that from the Fed would create a lot of chaos. And I think one of the points that Chair Warsh emphasized was that this new regime of reduced forward guidance was so was motivated in some part by
00:08:05
Speaker
the new ability of the Fed in this case to then take financial markets as a cue rather than having this kind of back and forth between Fed guidance and markets reacting and going going kind of circular with that.
00:08:16
Speaker
That's interesting. So so you're saying a bit more uncertainty near term, which means more volatility, maybe near term rates, but long term actually a bit of anchoring because maybe a more hawker stance. And so maybe long term rates feel more comfortable that inflation is coming down. But I want to ask ah Ryan here, because um there's been some suggestion that Chair Walsh might actually de-emphasize The current inflation measure that the Fed has traditionally targeted with its core PCE, um that famously, you know, is is kind of the the key benchmark, if you will, the inflation target.
00:08:51
Speaker
There's been in the run-up in recent weeks, a suggestion we could move to a different inflation gauge. Trimmed mean is one of these technical terms thrown about. Has there been any sign in or is it too early to talk about that? Because ultimately, if we change how we define inflation, back to your point about you know markets, that will introduce some uncertainty as to where the Fed actually is
Potential Changes to Inflation Targets
00:09:13
Speaker
targeting inflation. That so seems to me a big thing in the room. Was there any hint of that yesterday, Ryan? And this is, of course, also related to the 2% inflation target, right? that quote Yes, yeah exactly. Yeah.
00:09:24
Speaker
Yeah, absolutely. So the 2% inflation target, which is for headline PCE inflation, that was the one element that Warsh did confirm is here to stay.
00:09:35
Speaker
Now, this also relates to one of the task forces, right? There's a task force for that. So this was the third task force, which is related to the data sources. And so it did come up indirectly, even though I don't believe the trim mean measure was specifically talked about at any great length. But the...
00:09:52
Speaker
overarching vision from Kevin Warsh is that the Fed needs to analyze what are the true drivers of underlying inflation, right? And we can't necessarily just put all of our eggs in this traditional core PCE metric, which excludes food prices and energy prices, but instead, you know Maybe we do need to pay some attention to a trim mean measure which excludes the tails in terms of the most rapidly rising prices and maybe the prices on the downside that are actually falling to to get a sense of what is what is really you know the underlying
Foreign Investment in US Treasuries
00:10:21
Speaker
trend. I think if you look at all the data, it's very clear that right now inflationary pressures in the United States are not as broad-based as they were several years ago in the immediate aftermath of the pandemic. Having said that, we are in the midst of another sort of supply shock. There are clearly some evidence of of accelerating prices in certain areas. So it's that Judgment Act which is going to inform this debate about, well, how do you even measure inflation in the first place?
00:10:45
Speaker
Actually, I wanted to bring in Adiraj here because just from an Asian perspective, it a based in Hong Kong, and you know a lot of Asian investors are obviously still buying U.S. assets. And what's very important here is, I suppose, that that you get this ongoing demand for treasuries coming through from savers in Asia.
00:11:04
Speaker
um And if that confidence wavers, that would have a big impact, I suppose, on the Treasury market. Have you seen anything that foreign investors are starting to pull back amid uncertainty, for example, around the Fed transition, amid uncertainty around the U.S. budget deficit? Or in your analysis, does that not really matter? Is that not really big drivers?
US Deficits and Market Dynamics
00:11:30
Speaker
So I would say when it comes to kind of fiscal and supply demand narratives around the treasury market, it comes and goes in waves. So the fact that the U.S. is running elevated deficits is not a new story to anyone.
00:11:41
Speaker
But I think the times it comes into the market is sort of only when you have multiple overlapping narratives. for So, for example, last year when we had the big tariff announcements that coincided with the One Big Beautiful Bill Act, it coincided with the sovereign downgrade, it coincided with the debt ceiling is issue at the same time. So at that moment, there was ah signs of kind of these supply-demand issues feeding through, long-end rates really went up. But in hindsight, if you actually look at kind of the foreign flows data, especially around April of 2025, foreigners were actually barely net sold. The net outflow is in fact 40 billion only. And if you exclude Canada, there was actually positive flows into the US. So I think that any signs of confidence really shaking hasn't really fed through in the real time flow data. um But I think there is also this reality that we are seeing meaningfully higher, longer-term rates than we had been used to for so many years. And so I think there is this element of now that we have this premium, investors are somewhat comfortable with with the policy uncertainty and some of some of the volatility
Political Pressures on the Fed
00:12:45
Speaker
we've seen. Now that's a good time to take a short break. We'll be back with more soon.
00:12:53
Speaker
A quick message here from the Macro Brief team. If you're one of our listeners on YouTube, then we'll soon be moving. To ensure you never miss another episode of the podcast, be sure to head to HSBC CIB on YouTube and click the subscribe button.
00:13:11
Speaker
Now back to today's episode. And Fred, a question to you. How much discussion is there now in in Asia, for example, amongst the central banks that you cover so closely of any political influence on the Fed? Is that story slightly come and gone or is that another issue that could affect sentiments? Because especially if we do get into a situation where US interest rates might rise and if there is some political pushback, what do you think the implications would be of that?
00:13:44
Speaker
There are a lot of discussions ah because Asian investors are so overweight U.S. assets and that's the treasury market but it's also the equity market, right? There's a lot of apprehension in Asia about, you know, they follow U.S. developments very, very closely. And so when you have uncertainties around a new Fed, chairs coming in, you know The president has indicated rather have lower interest rates. You know, the question is being asked. I suspect that the Fed meeting that we just had in Warsh's Commons, which were interpreted slightly more hawkish, would put a lot of those fears to rest. And one might also argue that maybe that was an intent here, that in the first meeting to come out –
00:14:27
Speaker
erring on the side of hawkishness to put to the rest any doubts potentially. And that' so that's why also, you know and and Ryan has said that, it doesn't necessarily mean a hawkish comment that we will get rate increases, but maybe from messaging perspective, it was useful to have the first meeting or a little bit side on the hawkishness to reassure foreign investors.
00:14:47
Speaker
And I think I would echo that strongly. And I think the Treasury market's reaction has very much encapsulated that. And it was, to track back to the earlier point, I think in particular this firm commitment that we're looking to make a lot of change, but the 2% inflation target, whatever specifics with regards to the data that may be, that 2% number is not in question and the Fed will deliver on that. And i think that was important for long-end expectations to stay anchored and not have any fears that the Fed would tolerate.
00:15:15
Speaker
and you think That's right, yes. So that that communication strategy matters. The other thing, Alina, is that, of course, at the talking point in Asia is the U.S. deficit. So one is, you know, worries about, you know, does the Fed pursue its mandate? And maybe now these fears have subsided a little bit after the hawkish press conference. But we still run very large deficits here in the U.S. um you know I think even Americans are comfortable about this. um But that's something that foreign investors watch. And and so, Adiris, do you see a risk premium there coming in, not from an inflation perspective, effective but a little bit that you know the deficits ultimately matter? Or is it is it not yet really relevant And we're talking here about the fiscal deficits, obviously, not trade deficits, etc. Yeah, so the fiscal, the government spending, it's at historic high levels.
00:16:01
Speaker
Absolutely. And I think it is certainly something that comes into market focus once in a while, running 2 trillion deficits pretty much year on year, that's 6% of GDP. With regards to risk premium, I think we have priced some of that in, but I think one of the things that's kept it at bay recently, especially in the last two, two and a half years, is that the Treasury has refrained from increasing the supply of any of the Treasury securities from two years and beyond. So even though there's a need to fund the government and there is this deficit, it's being pretty much entirely funded incrementally. by issuing treasury bills. So very, very short dated debt that we still see very strong demand for for from money market funds. Even the Fed is now buying T-bills. So even though there is that deficit, there's not actually meaningfully more issuance coming through to the market. And I think the treasury has given us forward guidance saying, we're not going to do that anytime soon.
00:16:51
Speaker
And that's quelled some of those concerns about the market's need to absorb it. But that doesn't
Potential Fed Reforms by Kevin Walsh
00:16:57
Speaker
resolve the issue. It just kind of pushes it back maybe 2027, maybe the back half of this year comes back into focus.
00:17:04
Speaker
And so want to give Ryan the last word. Ryan, you've watched quite a few different Fed chairs in your career as a US economist. What's on your mind as you look ahead to Kevin Walsh's term in comparison to what you've analyzed and experienced previously?
00:17:21
Speaker
Well, I think what's clear is that there's an ambition to possibly make significant reforms, right? That is really what we can say at this at this point. ah We mentioned a few of the different areas that Kevin Warsh will be examining. One that we haven't talked about too much is the Fed balance sheet. And that's very much related to – what Deeraj and Fred were just discussing with respect to U.S. fiscal deficits and the relationship between the U.S. Treasury and the Federal Reserve. and And so I don't think that Kevin Warsh is necessarily going to make immediate judgments about these big picture issues related to exactly how the Fed conducts policy.
00:17:56
Speaker
So this year is going to be about inflation and whether or not the Fed ah actually hikes interest rates. And I think as we move into 2027, it's these broader issues that will potentially take the fore. which could be pretty interesting.
00:18:07
Speaker
There's a lot to watch for. Well, there's plenty
Fred Newman's New York Visit
00:18:09
Speaker
to discuss in a future podcast, Aline. I think we're going to be back. I think we're going to be back. thank You know where to find us. Yes. Thank you so much. And again, welcome to New York, Fred. you. Thanks for having me. yeah Yes, thanks. It's a pleasure to join you guys here in in the in the Big Apple, in the studio now. It's actually a historic day because the New York Knicks, there's ah a victory parade.
00:18:30
Speaker
They are basketball champions. Fred's looking at me with a blank face. No, i know I've heard of basketball. We have heard of the NBA and the Knicks, even in in Hong Kong. So congratulations to the Knicks. And i just my thought just went to the traffic later the day in New York City. Slight look of panic. It will all be over lunchtime. All roads are closed, don't worry.
Podcast Conclusion
00:18:52
Speaker
Thank you.
00:18:59
Speaker
So it's good to know that Fred has heard of basketball. Today's episode was hosted by me, Aline Van Dyne, in New York and produced by Tom Barton in London.
00:19:09
Speaker
Please like and subscribe The Macro Brief and Under the Banyan Tree wherever you get your podcasts. Until next week, thanks very much for listening.