Author: Wall Street News
The new Federal Reserve Chair, Kevin Walsh, is facing a policy choice with a distinct historical echo: raising interest rates might actually push long-term rates down, thereby achieving the Trump administration's much-desired goal of lowering mortgage rates.
As the Federal Reserve's policy meeting convenes this week, bond markets have priced in a 38% probability of a target increase in the federal funds rate, a significant jump from less than 10% before Walsh's testimony at the Senate Banking Committee hearing. Bloomberg Economics' Fed Official Sentiment Index indicates that the overall hawkishness of policymakers is currently at its highest since the start of the 2023 tightening cycle, with a marked hawkish tilt among the seven voting members.
Although a rate hike is not the base case this time, this logic chain is quietly circulating in the market: If Walsh uses a rate hike to reinforce his anti-inflation credibility, it could squeeze the inflation premium embedded in long-term rates, thereby pushing down real borrowing costs like mortgage rates and auto loan rates—precisely the outcome the White House truly desires.
This logic is not without precedent; history provides an example. The late Fed Chair Alan Greenspan faced a similar situation in 2004: The Fed raised its federal funds rate target from 1% to 4.75% by early 2006, yet long-term bond yields fell instead of rising, with the 30-year mortgage rate declining from a mid-2004 high of 6.34% to a low of 5.47% a year later. This phenomenon later became known as the Greenspan "Conundrum."
However, Bloomberg Opinion Executive Editor Robert Burgess points out that this is less of a "conundrum" and more a manifestation of the market's forward-looking pricing mechanism—each rate hike strengthens investors' assessment of the credibility of the central bank's commitment to fighting inflation, putting downward pressure on long-term rates.
Treasury Secretary Bessent is no stranger to the aforementioned logic. He explicitly stated early last year that his and President Trump's policy focus was on lowering long-term rates, not pushing the Fed to cut short-term target rates. Wells Fargo Securities Chief Economist Tom Porcelli highlighted this line of thinking in a research note to clients last week:
"We frequently hear from those who believe the Fed will raise rates soon that, by doing so, Walsh could achieve what he and Bessent truly want—lower long-term rates. The logic is that a rate hike would strengthen Walsh's anti-inflation credibility and compress the inflation premium embedded in the long-end of the yield curve."
Since taking over from Powell as Fed Chair in May, Walsh has consistently signaled a tough stance. At the July 15 Senate Banking Committee hearing, when pressed on whether he maintains communication with President Trump, Walsh stated clearly:
"I have said the same thing repeatedly to the President and the Treasury Secretary: They chose an independent person to do an independent job, and that is exactly what I plan to do."
Bloomberg Economics' assessment of the hearing noted that Walsh "showed his hawkish side unapologetically," believing the task of price stability is more severe than that of full employment after 63 consecutive months of inflation exceeding the Fed's 2% target. Walsh also pointed out that AI infrastructure construction is exacerbating inflationary pressures because demand-side shocks materialize faster than supply-side responses.
Notably, as Walsh spoke, the yield on the 10-year Treasury note fell, posting its largest single-day decline in three weeks—a miniaturized replay of the "Greenspan Conundrum," where hawkish talk actually lowered long-term rates.
Historical precedent is also worth examining. According to research by TS Lombard strategist Dario Perkins, Paul Volcker initiated rate hikes less than two months after becoming Fed Chair; Alan Greenspan, Ben Bernanke, and Jerome Powell all acted within one month of taking office. Only Janet Yellen was an exception—she didn't raise rates until 22 months into her tenure. Perkins wrote in a research note to clients:
"Newcomers always start hawkish; it helps build anti-inflation credibility. Volcker once summed up this atmosphere in one sentence, welcoming Greenspan's first rate hike with the words: 'Congratulations—you are now a real central banker.'"
However, practical constraints cannot be ignored. The latest inflation data show price pressures have moderated somewhat. The five working groups Walsh announced to conduct a comprehensive review of the Fed's operations are expected to release their findings by year-end—the timing of abruptly tightening monetary policy before these conclusions are announced is delicate. Furthermore, Walsh holds only one vote on the FOMC; changing the policy rate requires support from seven votes.
Still, with several members already hinting that further policy tightening may be needed, this threshold might not be as difficult to cross as it appears. Even if no hike occurs this week, the prevailing market judgment is: Walsh is systematically reinforcing his anti-inflation credibility, and that in itself may already be the most powerful precondition for pushing long-term rates down.
