Author: Wall Street Sights
New Fed Chair Warsh is facing a policy choice with historical echoes: raising interest rates might actually lower long-end rates, thereby achieving the Trump administration's long-sought goal of reducing mortgage rates.
As the Fed's policy meeting convenes this week, the bond market has priced in a 38% probability of a federal funds rate target hike, a sharp jump from less than 10% before Warsh's testimony before the Senate Banking Committee. Bloomberg Economics' Fed official sentiment index shows that the current decision-making body is the most hawkish since the 2023 rate hike cycle, with a clear hawkish tilt among the seven voting members.
Although this rate hike is not the base case, this logic chain is quietly circulating in the market: If Warsh uses a rate hike to solidify anti-inflation credibility, it could squeeze the inflation premium embedded in long-end rates, thereby lowering real borrowing costs such as mortgage rates and auto loan rates—exactly the outcome the White House truly desires.
Policy Lessons from the Greenspan "Conundrum"
This logic is not unfounded; history provides precedents. The late Fed Chair Alan Greenspan faced a similar situation in 2004: The Fed raised the federal funds rate target from 1% to 4.75% by early 2006, but long-term bond yields fell instead of rising, and the 30-year mortgage rate dropped from a high of 6.34% in mid-2004 to a low of 5.47% a year later. This phenomenon was later dubbed the Greenspan "Conundrum."
However, Bloomberg Opinion executive editor Robert Burgess points out that this is less a "conundrum" than a reflection of the market's forward-looking pricing mechanism—each rate hike reinforces investors' confidence in the central bank's commitment to fighting inflation, putting downward pressure on long-end rates.
Treasury Secretary Bessent is no stranger to this logic. He explicitly stated early last year that his and Trump's policy focus is on lowering long-end rates, not pushing the Fed to cut short-term target rates. Wells Fargo Securities Chief Economist Tom Porcelli also highlighted this line of thinking in a research note to clients last week:
"We frequently hear from those who believe the Fed will raise rates as soon as possible that Warsh, by raising rates, can achieve the outcome he and Bessent truly want—lower long-end rates. The logic is that a rate hike will strengthen Warsh's anti-inflation credibility and compress the inflation premium embedded in the long-end rate market."
Warsh's Hawkish Stance and Expression of Independence
Since taking over from Powell as Fed Chair in May, Warsh has consistently sent signals with a tough stance. At the July 15 Senate Banking Committee hearing, when pressed on whether he communicates with Trump, Warsh stated clearly:
"I have repeatedly told the President and the Treasury Secretary the same thing: They chose an independent person to do an independent job, and that is my plan."
Bloomberg Economics' commentary on the hearing noted that Warsh "unabashedly showed a hawkish stance," believing that after 63 consecutive months of inflation exceeding the Fed's 2% target, the task of price stability is more severe than that of full employment. Warsh also pointed out that AI infrastructure construction is exacerbating inflationary pressures because demand-side shocks materialize faster than supply-side responses.
Notably, as soon as Warsh finished speaking, the 10-year Treasury yield fell, recording its largest single-day drop in three weeks—forming a miniature version of the Greenspan "Conundrum," where a hawkish stance instead drove long-end rates lower.
New Chair Rate Hike Tradition and Current Constraints
Historical conventions are also worth examining. According to research by TS Lombard strategist Dario Perkins, Paul Volcker initiated a rate hike less than two months after becoming Fed Chair; Greenspan, Ben Bernanke, and Powell all acted within one month of taking office; only Yellen was an exception—she waited 22 months before her first rate hike. Perkins wrote in a research note to clients:
"Newcomers always start with a hawkish stance, which helps build anti-inflation credibility. Volcker once summed up this atmosphere when welcoming Greenspan's first rate hike: 'Congratulations — you are now a real central bank governor.'"
However, practical constraints cannot be ignored. The latest inflation data shows that price pressures have eased. The five working groups announced by Walsh are conducting a comprehensive review of the Fed's operations, with results expected to be released before the end of the year — tightening monetary policy abruptly before the review conclusions are released is a delicate timing. Moreover, Walsh holds only one vote on the Federal Open Market Committee, and changing the policy rate requires seven votes.
Nevertheless, given that several committee members have hinted that further tightening may be needed, this threshold may not be as insurmountable as it seems. Even if there is no rate hike this week, the market's mainstream judgment is that Walsh is systematically strengthening his anti-inflation credibility, and this itself may be the most powerful precondition for lowering long-term interest rates.
