Lookin’ Out the Window
In their signature Texas blues style, Stevie Ray Vaughan and Double Trouble sang about “Lookin’ Out the Window.” Today, Federal Reserve Chairman Kevin Warsh wants policymakers to do much the same, responding to economic conditions rather than committing to a predetermined path. After the Federal Open Market Committee’s (FOMC) latest meeting, Warsh also used the ensuing press conference to announce a change to the policy schedule. Henceforth, FOMC meetings will shift to a “6+2” annual format: six meetings to decide monetary policy and two meetings devoted just to discussing major economic issues. The transition to the new schedule will begin with one non-rate-setting meeting in 2027, followed by two in 2028.
As a result of these changes, each policy meeting is likely to carry greater significance. However, fewer scheduled rate decisions do not necessarily mean less communication from the Fed or fewer opportunities for it to act. “Having only six formal monetary policy meetings a year doesn’t preclude the Fed from taking action between meetings,” wrote Michael Jersey of Bloomberg Intelligence. “But by definition, those would be a surprise and also increase volatility.”
While Warsh has said that he wants markets to respond to economic developments rather than take their cues from the Fed, investors still take the Fed’s signals as a key input in their decisions. For example, two of this year’s biggest moves in the Treasury yield curve—the spread between two- and 10-year note yields— came on the days of Warsh’s first two Fed meetings, in June and July (Figure 1). The fourth-largest move came on August 28, when he delivered a hawkish speech at the Jackson Hole symposium. The new meeting calendar change is unlikely to diminish the market’s search for policy signals.
To that end, the FOMC’s latest rate decision was unchanged, but the language nevertheless carried a potentially meaningful signal. Officials described the economy as growing at a “strong pace,” an upgrade from the “solid pace” cited in June, July, and September. Warsh acknowledged that inflation remained elevated while productivity and capital investment were robust. “On the employment side of the Fed’s dual mandate, conditions are quite positive … yet Americans … are still dealing with inflation that has been running above the committee’s objective for close to six years. It’s our responsibility to get inflation down.” He described the coming six weeks as an information-rich period.
The FOMC’s statement reinforced that data-dependent approach: “The accumulation of more information will help the committee determine the policy stance appropriate to ensure a timely return of inflation to the committee’s 2% goal.” Taken together, the statement painted a picture of an economy that remains resilient despite restrictive monetary policy, reinforcing the FOMC’s argument that there is still time to assess incoming data before adjusting rates.
The October meeting concluded with two dissents. Fed Governor Lisa Cook and Cleveland Fed President Beth Hammack each preferred to raise rates by a quarter percentage point. (Hammack also dissented in July; Cook voted to stay on hold at the previous meeting.) Cook’s dissent is especially noteworthy because it means that a member of the Board of Governors, rather than a regional Fed president, has joined the ranks of dissenters. There is a key distinction. At FOMC meetings, the seven Fed governors are permanent voters, while only five of the 12 regional Fed presidents vote at any given time. As a result, when a dissent comes from a Fed president (such as Hammack), it is sometimes viewed as disagreement on the periphery of the committee. When a governor dissents, however, the disagreement has reached the Fed’s Washington-based board, suggesting a more consequential debate over the appropriate policy stance.
Cook’s dissent is particularly interesting because she recently emphasized that inflation risks concern her more than employment risks. On October 1, she explained the Fed’s traditional approach of largely looking through supply shocks: higher interest rates cannot produce more oil or stop a war, and an aggressive response could unnecessarily weaken employment and output. Recent experience, however, has
complicated that framework. “The supply shocks have had surprisingly persistent effects,” said Cook on October 1. “And we’ve seen more and more of them in the past few years, so they’re becoming more salient.” Her concern is that repeated one-off disruptions will produce persistent inflation pressure. Cook also identified the AI investment boom as another potential source of inflation, warning that the rapid buildout of AI infrastructure could create pressures that “may not resolve very quickly.” And she questioned how soon AI’s productivity benefits would generate disinflation and “where the supply bottlenecks are going to be next.”
Neil Dutta of Renaissance Macro noted that Cook’s dissent was her first in more than four years on the board. When trying to understand the mindset of FOMC voters (and Board members in particular), the policy direction of dissents matters too. For example, Governors Michelle Bowman, Stephen Miran, and
Christopher Waller dissented in favor of lower rates during Powell’s tenure, whereas Cook dissented in favor of a hike.
For all the focus on Cook, it’s worth noting that neither Dallas Fed President Lorie Logan nor Minneapolis Fed President Neel Kashkari dissented last week, despite some distinctly hawkish comments recently from both individuals. For instance, Logan argued in early October that a balanced labor market combined with inflation trending toward 2.5% left monetary policy “offsides.” She added that getting inflation back to target “will require tighter monetary policy” and estimated that rates needed to rise “an additional 50 basis points (bps) or more.”
Kashkari was similarly blunt, saying that inflation was “still too high” and that the Fed “will do what we need to do to get inflation back down to our target.” These examples show that while public comments can influence market expectations, actual votes will always remain the clearest indication of policymakers’ willingness to act. For now, many of the FOMC’s hawks appear content to keep the pressure on through communication, rather than formal opposition via dissenting votes.
Our takeaway was that the latest meeting leaned neutral-to-hawkish, but not hawkish enough to materially reprice market expectations. The two-year note yield, which roughly reflects expectations for the average policy rate over the period, traded around 4.57% at the close on Friday. This level—nearly 75 bps above the weighted-average rate implied by Fed officials’ projections over the next two years—was one of the widest gaps since dot plots were added to FOMC statements in 2012 (Figure 2).
In other words, market participants entered the meeting pricing a substantially more restrictive policy path than the Fed itself projected. The burden on policymakers to surprise investors with even stronger hawkish messaging was, therefore, exceptionally high. That the market has been trading much higher than the Fed’s own estimates suggests that the doves had largely left the proverbial building before the meeting even began.
Even though the Fed didn’t raise interest rates, Americans are still seeing higher borrowing costs; financial conditions have tightened at the margin, too. Meantime, Ginnie Mae project loan and Fannie Mae DUS interest rates have risen to near post-pandemic highs (Figure 3). Jumbo 30-year residential mortgage rates have followed a similar path, leading to a similarly challenged housing market.
Economic data arrives with a lag, leaving policymakers to assess an incomplete picture. Even so, Warsh’s emphasis on elevated inflation and otherwise strong activity offered investors something to interpret. For instance, Eric Winograd, chief economist at AllianceBernstein, said he was surprised by the amount of forward guidance in the FOMC’s post-meeting statement: It was “a pretty clear hint that they are likely trying to hike in December unless the inflation data moderate.”
Warsh, by contrast, was tight-lipped. When asked about a December hike, he replied: “I don’t believe in it. I don’t favor it. I also don’t believe in prejudging meetings. A lot of things can happen.” In short, as December approaches, Warsh will be lookin’ out the window for economic data—and investors will still be looking to the Fed for clues about its next move.
FROM THE DESK
Agency CMBS — New issue Fannie Mae DUS volume was around $800 million last week; spreads were flat to one bp wider, week over week. Ginnie Mae project loan spreads widened considerably the past few weeks on large supply and poor REMIC execution. Spreads on discount project loans are particularly challenged, as investors now generally shun lower coupons. Additionally, investors are more cautious about construction loans with longer construction periods (i.e., 20 months or more).
Municipals — AAA tax-exempt yields moved lower across the curve for a third consecutive week. With the Fed meeting last week, market activity was significantly quieter and only a handful of multifamily deals priced. Overall, the municipal market continues to stabilize following the volatility seen a month ago. Several refunding transactions that were pulled during that period have since returned under more favorable market conditions. Compared to September 2, 10-year MMD is one bp lower, while 30-year MMD is 15 bps higher. Investor demand remains robust, highlighted by a fourth consecutive week of municipal bond mutual fund inflows exceeding $1 billion, including $546 million into high-yield funds. Over the past four weeks, municipal bond funds have attracted approximately $6 billion of inflows.
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell, any securities referred to herein. Lument Securities, LLC may from time to time have a position in one or more of the securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
