Fed Officials Tread Carefully After Treasury's Bond Market Intervention

• Two Federal Reserve (Fed) officials expressed caution on Thursday when asked how the Treasury Department's debt management changes ​could affect the U.S. central bank's monetary policy choices. Long-term Treasury yields recently spiked on concerns about the U.S. government's rising debt, inflation that remains stubbornly above the Fed's 2% target and the ​implications for investment flows. The impact of Treasury's intervention appeared short-lived, as yields rose again on Thursday after dropping sharply on Wednesday.
• The intervention creates potential challenges for the Fed because of the possible confusion in financial markets as to which institution is the main driver of financial conditions. While easing financial conditions, all else being equal, Treasury's move could lead to friction with a Fed that may yet raise rates to help cool down inflation.
• Bessent on Thursday downplayed any conflict and said any Fed rate decision is completely separate from what the Treasury is doing. And in terms of anything that might impact the U.S. central bank's balance sheet, the two institutions “would work together if there was any change in the (Fed) balance sheet, and we ... would adjust to any kind of runoff (of bonds) that they're doing," the Treasury secretary said.
• If financial conditions are now supportive of economic growth and ​not working to lower price pressures, Treasury's intervention, to the extent it engineers a sustained drop in yields, would move markets even further from where the Fed would ‌like them ⁠to be. And that scenario would in turn bolster the case for raising the central bank's benchmark interest rate.
• Musalem, who thinks the Fed should have raised rates rather than kept them steady in the 3.50%-3.75% range at its July 28-29 meeting, suggested he was leaning toward a hike at the September 15-16 meeting. He noted that "financial conditions are pretty accommodative here." Speaking to Bloomberg Television, San Francisco Fed President Mary Daly said current long-term bond yields do not "give us a lot ​of signals about what we should ​do in the policy adjustments or ⁠the policy calibration for the Fed."
• Daly said she thinks Fed policy is a "good place" while adding that she's watching longer-dated bonds to see what they imply for the outlook. She noted that she strongly supported the Fed's decision to ​leave rates unchanged last month.
• More issuance at the front end could put upward pressure on market rates, creating technical ⁠challenges for ​how the central bank manages interest rate policy. The Fed's rate-control system depends on ​influencing money market conditions to manage interest rates by way of a series of tools and liquidity facilities. Daly added that the key issue for the Fed is less about the "mechanics" of how it ​achieves its inflation and employment mandates than its commitment to do so and ability to achieve them

(Source: Reuters)