Federal Reserve Chair Kevin Warsh, in a closely watched speech, emphasized the central bank's need to contain prices, alleviating some bond market concerns about his credibility in fighting inflation and pushing short-term US Treasury yields higher. During his remarks at the annual Jackson Hole symposium in Wyoming, traders increased their bets that the Fed could begin raising interest rates as soon as next month.

This expectation drove the two-year Treasury yield up as much as 10 basis points to 4.33%, while the 30-year yield fell roughly 2 basis points to 5.17%. The flattening of the yield curve reflects market expectations that the Fed may need to raise short-term rates to gradually cool inflation and suppress longer-term borrowing costs. On Friday, Warsh warned that inflation has not shown substantial slowdown and pledged to bring it back to the Fed's 2% target at a "sufficiently fast pace," describing the goal as "firm and fixed."

"People perceive him as hawkish," said Shiyan Cao, portfolio manager at hedge fund Winshore Capital Partners. Cao noted that Warsh "conveyed a sense of urgency" in cooling inflation. Following Warsh's speech, traders further increased their bets on Fed rate hikes. Interest rate swaps indicate that the market now prices in a greater than 50% probability of a 25-basis-point hike at the September 16 meeting, with at least one hike before year-end nearly fully priced in.

Where to begin

The market reaction suggests Warsh has somewhat eased investor doubts about his policy stance, which had caused significant volatility in the bond market over the past few months. At his first press conference in June, Warsh struck a hawkish tone, emphasizing the need to suppress inflation that has remained elevated since the global economy emerged from the pandemic in 2021. However, after the Fed held rates steady again in July and Warsh declined to signal whether a hike was possible this year, long-term Treasury yields surged as traders demanded higher returns to compensate for the risk of persistently high inflation.

George Catrambone, head of fixed income at DWS Americas, commented: "No matter how you frame it, this is exactly the forward guidance the market wanted to see at the July FOMC meeting. His remarks exceeded expectations by a wide margin, downplaying wage inflation and suggesting policy isn't truly restrictive. That's a fairly significant 180-degree turn."