Daniel Varela: "Bond markets will continue to test Kevin Warsh"

Markets emerged from Wednesday's meeting of the US Federal Reserve (Fed) with more questions than answers. Its Chair provided little guidance on his intentions regarding interest rates or the future direction of the Fed. Daniel Varela, Chief Investment Officer at Piguet Galland, shares his analysis.

Wednesday's Federal Reserve meeting was closely watched, as there was an unusual degree of uncertainty surrounding its interest rate decision. The consensus expected short-term rates to remain unchanged, but nearly one-third of observers did not rule out a 0.25% rate increase. Rates ultimately remained within the 3.50% to 3.75% range, but markets are now facing even greater uncertainty ahead of the Fed's next meeting in September. Daniel Varela, Chief Investment Officer at Piguet Galland, explains why.

Le Temps: Why did investors come away from Wednesday's Federal Reserve meeting feeling uncertain?

Daniel Varela: Because they learnt very little about its intentions. Before taking office, Kevin Warsh had indicated that many aspects of the Fed would change. One of the most significant changes is that he has abandoned forward guidance – the Fed's practice of signalling its thinking and intentions in advance. Both the statement and the press conference remained deliberately vague, despite a particularly complex backdrop marked by the impact of the war in Iran on oil prices and, consequently, US inflation. In addition, some of his answers caught markets by surprise.

Which ones?

Firstly, he downplayed the short- and medium-term inflationary impact of artificial intelligence, which is pushing up the price of computers and memory chips. Secondly, when asked about the tensions seen in long-term bond yields over recent months, he said this was not a concern because the bond market was effectively doing the Fed's job by tightening monetary conditions. However, markets expect the Fed Chair to be the one setting monetary policy.

What are markets expecting now ahead of the September meeting?

Before Wednesday's meeting, interest rate futures implied more than a 30% probability of a rate increase at that meeting and a 100% probability of a hike in September. Following the meeting, that probability fell to around 60%. Markets are now far less certain, which is also reflected in the steepening of the yield curve. Short-term yields eased slightly, while the 30-year Treasury yield rose above 5.20% at the close, a level not seen since 2007. When markets believe the Fed is not paying enough attention to inflation risks, inflation expectations rise, pushing bond yields higher.

Three of the Fed's twelve voting committee members supported an immediate rate increase. How should this be interpreted?

These three dissenting votes are unusual and highlight differing views within the Federal Reserve, adding to the prevailing uncertainty.

Finally, what should investors be watching over the coming weeks?

The 30-year Treasury yield, which is important for mortgage markets, could have an impact on the construction sector. However, the 10-year Treasury yield will be even more important to monitor, as it is widely used as a benchmark for corporate financing. It closed at 4.70% on Wednesday, approaching the psychologically important 5% level reached in 2023. Markets will be closely watching how the Fed responds. Whenever a new Fed Chair takes office, bond markets test that person's resolve. That is precisely what we are seeing today, and it is likely to continue for some time.

Full article (french only)