The Federal Reserve has decided to keep its benchmark interest rate steady at 3.50% to 3.75%. While this decision was anticipated, the market reacted sharply. The yield on 30-year U.S. Treasury bonds surged to 5.2%, and stock prices plummeted. Long-term Treasury yields reached their highest levels since the financial crisis.
In this decision, three of the twelve members of the Federal Open Market Committee advocated for a 0.25 percentage point increase. This indicates that there were significant calls for further tightening, considering inflation and international oil prices. However, Federal Reserve Chair Kevin Warsh, while opting to maintain the current rate, conveyed a hawkish message, stating, "We will not hesitate to act if necessary." His actions were dovish, but his words were hawkish.
Warsh was appointed by President Donald Trump and took office in May. Trump has openly called for the Fed to lower interest rates to stimulate the economy and reduce the government's interest burden. Concerns have been raised since Warsh's nomination that he may prioritize the president's wishes over inflation and economic indicators.
It is difficult to categorically label the decision to freeze interest rates as a mistake. While inflationary pressures have increased due to war and rising oil prices, the risk of economic slowdown cannot be ignored. The issue lies in the Fed's failure to gain the market's trust with its judgment and explanations. While expressing concern over inflation, the Fed opted for a freeze and did not clearly outline its future direction. This has led to suspicions that the Fed is delaying necessary actions due to political considerations rather than inflation concerns.
This has led to interpretations that a so-called 'bond vigilante' movement is underway. Investors, believing that the government or central bank is ignoring inflation and fiscal soundness, are selling off Treasuries to send a warning to policymakers. The recent surge in Treasury yields is effectively a vote of no confidence in the Fed's decision to maintain rates.
Market-driven tightening can be more severe than the Fed's rate hikes. When Treasury yields rise, mortgage rates, corporate loans, and corporate bond rates also increase. This raises the U.S. government's interest burden on its debt and dampens corporate investment and household consumption. The Fed has kept rates steady to stimulate the economy, but rising market rates could shock both the real economy and financial markets.
A more serious issue is the erosion of trust in the Fed. Monetary policy involves not only actual interest rate adjustments but also managing market expectations. If the central bank is perceived to be swayed by politics, no matter how strong its statements are, the market will not believe them. When the power of words diminishes, the Fed may have to implement larger rate hikes later to restore trust, and the costs will be borne by the public and businesses.
The Fed's misjudgment does not only affect the U.S. The rise in U.S. Treasury yields attracts global capital to the U.S., pushing up exchange rates and market rates in other countries. This can lead to capital outflows and currency depreciation in emerging markets, impacting bond and stock markets in South Korea as well.
Warsh must prioritize responsibility for inflation, employment, and financial market stability over the wishes of the president who appointed him. If the situation calls for rate increases, he should raise them, and if a freeze is necessary, he must persuade the market with economic indicators and logic. Merely presenting a hawkish facade without taking action will not maintain trust. If politics holds the central bank's rates hostage, the market will demand higher rates as compensation.
* This article has been translated by AI.
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