In an ideal world, the financial infrastructure of our economy should hum along smoothly. The Chair of the Federal Reserve and the Treasury Secretary should sit anonymously in their offices, monitoring but not actively manipulating the economy.
In particular, they should not manipulate the economy at cross-purposes to each other.
Last week, Treasury Secretary Bessent and Fed Chair Warsh made front page news. They manipulated interest rates in opposite directions.
Bessent sold short-term T-bills (which pay for government deficits) in order to buy long-term Treasury bonds (whose yields have been spiking recently). It’s important to note that this action was revenue-neutral. Unlike the Fed, Treasury can’t create fiat money out of thin air. Bessent’s motivation was to reduce interest payments on the federal debt. This was an unplanned re-weighting of government debt toward a shorter duration. If short-term interest rates rise, the T-bills will quickly turn over to the higher rate.
Meanwhile, Fed Chair Kevin Warsh, who has specifically rejected forward guidance, gave a speech that strongly hinted the Fed will need to raise the fed funds rate since the current rate is not restrictive and inflation has been running above the Fed’s goal for 5 years.
The Fed controls the overnight fed funds rate. Barring an emergency, the Fed doesn’t buy longer term bonds (QE) which would suppress the long term bond yield.
Treasury’s move to lower the 30 year bond yield works against the Fed’s efforts to slow inflation by slowing the economy. Worse, it was stupid (because the small amount bought was a drop in the ocean) and bond yields rose after a temporary drop.
T-Bill and 2 year yields spiked after Warsh’s speech. That won’t make Bessent happy since his job is to reduce interest payments as much as possible.
The entire yield curve rose, especially in the < 10 year duration. I was able to buy an A+ rated muni maturing in 3 years yielding 5.6%.
The Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems, showed that conditions are very loose and getting looser.
The Atlanta Fed’s Third-Quarter GDPNow Estimate for 2026:Q3 is 4.6%. That’s a very high prediction which would lead to increased inflation.
The Cleveland Fed’s inflation forecast is, as usual, higher than the Fed’s 2% target. Warsh sees the Fed’s Job One as bringing inflation down.
Thanks to mungofitch on Shrewd’m who just turned me on to the Divisia M3. The Divisia M3 broad money supply substitutes for the discontinued Federal Reserve M3. The Divisia M3 shows rapid growth in the money supply, which isn’t surprising since it correlates with the very loose financial conditions. The chart shows the stable level of M3 between 2012 and 2020, when inflation was negligible. The growth rate skyrocketed during the Covid money-pumping years which caused inflation. It’s concerning that M3 growth, after declining in 2022-2024 due to the high fed funds rate, is now back up to 6%. If this rate stabilizes in the future inflation should be tame. But if the growth trend continues ahead of past levels inflation could increase.
The Velocity of money - how fast it’s being spent and not just sitting still in time accounts - also impacts inflation. After declining during the Covid years, V2 is back to its pre-pandemic normal.
The options market sees a 60% chance of a fed funds rate hike before the November midterm elections and no chance of a cut. Everyone can see the high inflation and high growth. The Fed would totally lose credibility if it cut the fed funds rate. It should have raised the rate months ago and everyone knows it. The only opponent is President Trump - and he doesn’t hesitate to browbeat and viciously insult anyone who opposes him.
The stock indexes stabilized. The Fear & Greed Index was neutral. The stock market bubble is still inflating.
The price of oil and gasoline have stabilized. Diesel oil is rising, which will pressure inflation higher. Gold and silver pulled back slightly from their recent rise. Copper has been rising steadily, probably due to AI data center wiring needs. USD stabilized near the bottom of its 2026 channel.
The METAR for next week is sunny. The world is wagging on with all its usual problems. There’s no sign of a crisis next week. All the problems are long-term.
Wendy
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
