Federal Reserve Chairman Kevin Warsh will deliver an important speech next week in Jackson, Wyoming. It may prove to be as notable for what he doesn’t say as for what he does.
The federal debt is now at $40 trillion, more than 120% of GDP, and climbing. The interest on the debt now exceeds $1 trillion annually, and the bond market knows this trajectory is not sustainable. Thirty-year Treasury bond yields are well above 5%, and without the Treasury’s recent intervention to buy back some of them, the rate would likely be higher still.
The Fed is pegging the short end of the yield curve but, to its credit, has avoided intervening in the long end, leaving the private sector as the primary source of demand for longer-term notes and bonds — a risky business at this stage.
A showdown is clearly brewing.
The market wants to know whether the Fed will purchase debt at the longer end of the yield curve or instead force the government’s hand by requiring it to confront its debt overhang through deficit reduction, which is why central banks are supposed to be independent.
I doubt Mr. Warsh will say much about the nation’s debt. I anticipate he will reiterate that the 2% inflation target is non-movable.
Perhaps the Fed is counting on higher long-run rates to slow the economy and lower inflation. If so, I hope it works.
At this moment, one thing can be said with confidence about the chairman’s remarks next week: The market will be listening carefully. As for me, I will be listening too but watching the balance sheet especially carefully.