Fed behind the curve on inflation as Warsh takes over

Bond market investors believe the Federal Reserve needs to catch up with inflation as the new leader takes over, according to Ed Yardeni, president of Yardeni Research.

Yardeni said Wall Street expects the central bank to reverse its bias towards cutting interest rates at the Federal Open Market Committee’s policy meeting next month. Bond traders hope it will be replaced by a trend towards tighter monetary policy, the economist said.

Yardeni’s evidence: 2-year US Treasury its yield is above the federal funds rate, or FFR. When this happens, investors are implying that they do not believe the FFR is high enough to reduce inflation.

“The market is signaling that the current FFR is too low to curb inflation and may need to be raised,” Yardeni said in a note to clients Wednesday. he wrote.

Yardeni added that the Fed may have to show it is willing to raise interest rates after inflation has been above the annual target of 2 percent for five years.

“Simply eliminating the tendency to relax may not be enough,” he said.

Yardeni’s comments follow a series of inflation readings this week that showed a renewed acceleration in the wake of the Iran War. That could complicate the trajectory of Kevin Warsh, President Donald Trump’s pick to replace Fed Chairman Jerome Powell.

The consumer price index for April increased by 3.8% annually, the highest rate since 2023. Wholesale inflation increased by 6% in the last 12 months in April, its fastest rise since 2022.

Warsh, who was confirmed by the Senate this week, has promised “regime change” at the central bank. Trump has long been pressuring the Fed to lower interest rates, arguing that lower borrowing costs would benefit the economy.

However, Fed fund futures investors are pricing in that there will be no interest rate cut for the rest of the year. CMEGroup’s FedWatch tool. The possibility of an interest rate increase that the market has priced in has increased in recent days.