Trump’s Fed appointee signals a rate rise and challenges Bessent on Treasuries

For the speech most eagerly awaited by the markets this summer, the Chair of the Federal Reserve chose a title that was no coincidence: ‘In our time’, the same one used by Ernest Hemingway in 1925 for a collection of short stories. For Kevin Warsh, "our time" is the moment when the man chosen by Donald Trump to cut interest rates takes to the stage at Jackson Hole – the gathering of central bankers from around the world – and says he might raise them. Hemingway made the ellipsis his method, and indeed Warsh was of few words on the subject: if inflation does not return towards the 2 per cent target “clearly and with sufficient speed, we will have work to do. It is our job, our mandate, our commitment. The responsibility for 65 months of high and prolonged inflation lies entirely with the Central Bank,” he thundered from the mountains of Wyoming.

Year-on-year US inflation, as measured by the index the Fed uses as its main benchmark, stands at 3.7 per cent. That is almost double the target. The latest figures were better than expected, but for Warsh they are not enough to prove that the surge in prices is slowing down. He argued that the economy continues to hold up, unemployment stands at 4.1 per cent and credit shows almost no sign of the monetary tightening, despite interest rates being high and likely to rise. In July, the Fed had kept them unchanged, at between 3.50 and 3.75 per cent. But even during that July meeting, three of the twelve members of the Federal Open Market Committee (FOMC) had voted to raise them. 

Warsh, in line with the abandonment of forward guidance – that is, the Fed’s indication of its forthcoming moves – made no commitment regarding September: before a rate rise, he said, very convincing evidence would be needed. But the door has been left open, whether Trump likes it or not, and the markets have taken note.

Warsh thus set out his view of the central bank: “Short-term interest rates are the predominant tool for achieving the dual mandate”, namely the pursuit of price stability and maximum employment. “Unconventional policies”, such as asset purchases, “should be reserved for genuine crises – the Fed chairman clarified – or used sparingly. If not avoided altogether.” Above all, Warsh stated—without ever mentioning U.S. Treasury Secretary Scott Bessent—that Treasury prices, i.e., U.S. government bonds, must be allowed to reflect what investors think about inflation and public finances, without the authorities immediately attempting to correct them.

The reference to Bessent and the Treasury’s decisions is, however, clear. In fact, just over a week ago, on 19 August, whilst the federal debt had exceeded 40,000 billion dollars – more than double the figure from 2017 – the Treasury Secretary had announced plans to buy back long-term securities. He then added that these would begin on 9 September – a week before the Fed’s interest rate decision – and could exceed $4 billion. For Bessent, Treasury yields “do not reflect the fundamentals”, and he is prepared to change their cost. The reality, however, is that the fundamentals have very clear reasons for being so high. The US federal deficit stands at nearly 6 per cent of GDP, almost $2,000 billion, and according to the US Congressional Budget Office (CBO), net interest expenditure alone will exceed $1,000 billion this year. A financial black hole. And the government’s demand for capital must also take into account the ever-increasing demand from companies engaged in the AI race. It is no coincidence that, two weeks ago, 30-year Treasuries were yielding 5.31 per cent – the highest since 2007 – whilst yesterday they hovered around 5.20 per cent.

All signs of a minor institutional rift: Warsh is calling for government bonds to send clear, transparent signals to the Fed and the market; Bessent believes that, beyond a certain threshold, yields need to be corrected. Meanwhile, the Treasury Secretary, alongside President Trump, is grappling with the war against Iran and ‘Operation Economic Outcast’, which aims to turn Tehran into an economic pariah. Indeed, yesterday’s decision was taken to remove a UAE bank, Banque Misr UAE, from the banking clearing system on charges of having transferred around two billion dollars, between 2024 and 2026, to companies linked to the Pasdaran.

In any case, a rift between the head of the Fed and the head of the Treasury is not yet imminent. Bessent backed Warsh’s candidacy and both were appointed by the President himself. What separates them, for now, are their objectives and the methods they intend to use to achieve them. The Fed must restore its credibility in tackling inflation, whilst the Treasury must contain the cost of an ever-increasing debt burden.