While the outcome of the July FOMC meeting itself was in line with expectations, the aftermath has proven to be far more challenging for the money and bond markets, especially for longer-dated maturities, a.k.a. duration. Investors, as well as Fed Chairman Warsh, have quickly discovered something we have been highlighting about over the last few months: a lack of forward guidance can have unintended consequences.

It is truly noteworthy that after Chairing only two FOMC meetings Warsh’s credibility has been called into question. The sell-off in the U.S. Treasury 10, 20 and 30-year maturities has underscored this point post-FOMC meeting. Here’s some perspective:

• The UST 10-year yield has risen by +20bp from mid-July and is approaching the 4.80% level
• The UST 20 & 30-year bonds have also witnessed yield increases of roughly +20bp during this timeframe, with both going over the 5.25% threshold
• The long bond yield is now at its highest level since 2007

Why is This Happening?

The primary reason for this surge in bond yields is due to the fact that Warsh’s press conference was viewed as a failure of sorts. The bond market could have lived with the decision to keep rates on hold, but the culprit was the lack of any guidance from the Chairman as to what could trigger a response from the Fed to raise rates, especially given the rhetoric around the Fed’s commitment to price stability. Yes, the money and bond markets have tightened for the policymakers, a development Warsh did acknowledge, but he is quickly finding out that there are limits to his approach without any guidance whatsoever.

What Could Come Next…Getting ‘Boxed In’

Thus far, Warsh has taken the approach of talking hawkish on inflation, but for the bond market, the ultimate arbiter is ‘action’. Between now and the September 16^th FOMC meeting, the Fed will be provided with two more monthly jobs and CPI reports. If these data releases continue to show the labor markets not ‘cooling’, as was the case the last two years, and inflation remaining ‘sticky’ and above Fed target, the bond market will ‘demand action’, with Warsh finding himself ‘boxed in’ and then having little choice but to raise rates.

Bottom Line: Duration & Volatility Risks

Hopefully, Chairman Warsh comes to the realization that the markets and the Fed are in this together. The money and bond arenas respond not just to the incoming data itself, but perhaps more importantly, how the Fed may respond as well. To put it another way, the markets essentially try to determine what the policymakers’ ‘reaction function’ could be to the economic and inflation inputs. Without the Chairman’s participation, the bond market is vulnerable to misinterpretations which creates a backdrop of heightened duration and volatility risks.