Fed Chair Warsh’s speech on Friday was more hawkish than expected, and we did see Treasury yields rise (the 10-year climbed 5 basis points 05%), and that ultimately pressured growth stocks (both the Nasdaq and the Russell 2000). But while that one-day reaction was negative, the Fed getting slightly more hawkish for markets is not an automatic market negative.
Normally, it is true that a hawkish Fed is negative for stocks. Generally, that’s because investors have been trained to always want lower rates (which support economic growth). More officially, higher rates reduce the value of future cash flows (because you can earn more now in a “risk-free” investment), and that, in turn, lowers market multiples.
However, these are not normal times. The U.S. economy has an inflation problem. That is not debatable. What is debatable is how bad this problem is and how long it can reasonably be expected to last. The reality is the Fed has not reached (or even come that close to) its 2% inflation target in five years! So, investors want to know if the Fed is serious about containing inflation, and this isn’t a theoretical desire.
Uncontrolled inflation saps consumer spending and pressures stocks because long-dated yields rise (which hits stocks). Part of the reason yields have risen recently is that the Fed’s credibility on inflation is eroding. That erosion really accelerated when Fed Chair Warsh talked about changing most things at the Fed, and later, when it was revealed that he was in frequent contact with President Trump and Treasury Secretary Bessent.
Warsh’s speech on Friday, which rightly increased expectations for a rate hike in September, helped to halt and reverse that erosion of Fed credibility on inflation. Yes, yields rose, and growth stocks dropped as a result, but if the Fed hikes rates once in September, that will help reestablish credibility that they are serious about solving the inflation problem. A hike (or maybe two) in September and/or before year-end is unlikely to hurt economic growth (the economy is on solid footing and 25 or 50 bps of rate hikes shouldn’t change that).
So, a hike or two could reestablish Fed credibility on inflation, which should push the 10-year and 30-year Treasury yields lower, creating a tailwind on stocks. That’s the positive scenario, and it’s reasonable. What we don’t want to see is the Fed hike rates and say it’s the start of an extended rate hike campaign, which means rates will likely go much higher. That would be negative for stocks and bonds (like we witnessed in 2022).
Bottom line, rising yields are a problem for this market, and they aren’t going to be fixed quickly, but fixing them is important. A rate hike or two, along with restored Fed credibility, would be a medium-term positive for markets and likely ultimately lower long-dated yields, and that is why, in this case, hawkish is not necessarily bad for stocks (beyond a short-term reaction) on the legitimate risks to markets.
Source: Sevens Report 9-1-26