Markets Reverse Course on Kevin Warsh’s Fed: A Chart of the Day

Two weeks ago, Federal Reserve Chairman Kevin Warsh stated that markets had done a considerable amount of the Fed’s tightening. However, Wall Street has since taken it all back and then some.

A gauge of US market conditions published by Bloomberg reached its easiest level since 1996 on Thursday, marking a remarkable reversal from late July. The index in question is specifically designed to track market signals, such as rising stocks, calmer markets, and cheaper corporate borrowing, which all contribute to making markets easier.

Between Warsh’s first Fed meeting on June 17 and his next on July 29, Treasury yields rose, stocks slipped, volatility jumped, and corporate borrowing became more expensive. The Fed left its benchmark rate untouched at 3.5% to 3.75%, but markets tightened around it.

Warsh’s statement that ‘the markets have done quite a bit’ was made in the context of this tightening. However, since July 29, the S&P 500 has jumped nearly 7%, the VIX volatility gauge has dropped six points to the lows of the year, and junk-bond borrowing costs have fallen.

The appetite for risk is already showing up across the market, with Wall Street’s riskiest trades suddenly back on top. This includes Cathie Wood’s ARK Innovation ETF (ARKK), IPOs, and other speculative corners that had been left behind.

It’s worth noting that this reversal is not happening because long-term interest rates have suddenly collapsed. Instead, they remain high, with the 10-year Treasury yield having actually risen since Warsh’s first meeting. The Fed has stayed put, yet the chart’s measure of market conditions has raced to a 30-year extreme.

Risk-free money is still expensive, but Wall Street has made risk cheaper anyway. This could complicate Warsh’s job, as a continued stock market climb, low volatility, and falling borrowing costs could add fuel to an economy the Fed is still trying to cool.

The hotter Wall Street runs, the less help Warsh gets from it – and the more work may fall back on the Fed. Warsh has made it clear that he’s listening to this signal, stating that holding the Fed’s rate steady doesn’t mean nothing has changed.

In fact, Warsh believes that this is the beginning of the story, not the end of it. He’s listening to the signal that markets can reinforce what policymakers are trying to do – or pull hard in the opposite direction.