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Markets test Fed clarity as Warsh links easing inflation to yields

Citadel Securities warned that letting markets tighten conditions could create a feedback loop where higher yields delay Fed action and lift inflation and term premiums.

Reported · Written up by our desk · Central Banks

Citadel Securities said Federal Reserve Chairman Kevin Warsh is raising investor uncertainty by pledging to rein in inflation without detailing the path to get there. The assessment comes as the Fed left interest rates unchanged last week, even though three policymakers favored an immediate increase.

Warsh has argued that consumer-price inflation must be tamed after running above the Fed’s target for five straight years, and that the recent rise in Treasury yields has already tightened financial conditions. Citadel also highlighted Warsh’s suggestion that the Fed could revisit whether its preferred inflation gauge should remain the current benchmark following the policy framework review.

In response to the Fed stance and Warsh’s messaging, investors sold long-term Treasuries, pushing up inflation expectations and sending the dollar and stocks lower. Citadel’s Nohshad Shah said the reaction reflected a challenge to the credibility or clarity of the Fed’s policy framework.

Shah warned that relying on markets to tighten financial conditions may backfire by creating a negative feedback loop. He said higher long-term borrowing costs could encourage the Fed to wait longer before raising rates, prompting investors to seek higher inflation and term premiums, which would drive yields higher further, and that not all yield moves tighten conditions the same way.

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