Tag: Federal Reserve

Asset Allocation Bi-Weekly – The PCE Makeover (August 3, 2026)

Posted on by Amanda Ahne

by Thomas Wash | PDF

The Federal Reserve’s preferred gauge of price inflation is set for a methodological update, as the Bureau of Economic Analysis (BEA) is expected to implement revisions to its price index for Personal Consumption Expenditures (PCE) as early as September. Early estimates suggest the changes will modestly lower measured PCE inflation, potentially easing the path toward the Fed’s 2% target by reducing the index’s sensitivity to the AI-driven stock market rally.

The timing is notable. As shown in the chart below, the Fed has failed to achieve its inflation objective over the past five years, and a downward shift in the index could finally make the target more attainable — both mechanically and in perception.

The revisions to the PCE price index, scheduled for incorporation in the September 30 release, aim to better align the index with actual household spending patterns. Key changes include updates to core inflation calculations and modifications to several categories that have disproportionately influenced recent readings, namely legal services, portfolio management, and computer software and accessories.

The most consequential adjustments are likely to come from portfolio management and software-related components. The BEA will revise its software price index — an area that has been distorted by the surge in AI-fueled demand — by incorporating a broader set of prices, including video game software and web hosting services. This change is expected to lower measured inflation by roughly 0.1 percentage points.

In parallel, the treatment of portfolio management services will shift away from a fee structure tied to assets under management and toward a measure based on firm revenues relative to services rendered. This adjustment is expected to reduce inflation by an additional 0.2 percentage points. Legal services will also be revised, with greater reliance on producer price data, though the impact there is likely to be more modest.

These changes are small but important, since these components have contributed disproportionately to volatility in the core PCE index. While the components account for roughly 4% of the core PCE index, they represent just over 1% of the core consumer price index, underscoring their outsized influence. Their growing weight has amplified swings in measured inflation, complicating the Fed’s effort to return inflation sustainably to target following years of overshooting.

The divergence largely reflects differences in weighting methodology. PCE weights adjust dynamically with shifts in consumer spending, and in recent years, portfolio management services have captured a larger share of expenditures amid rising retail participation in financial markets. At the same time, the recent surge in demand for computing and software has increased the relative weight of technology-related categories.

As a result, the PCE price index has become more sensitive to equity market dynamics. The chart above highlights the close relationship between rising asset prices and the growing influence of these components, suggesting that a portion of recent inflation pressure has been indirectly linked to strong market performance. This relationship has not gone unnoticed by Fed Governor Miran, who has suggested that a strong stock market should not count toward inflation.

These revisions will likely lower recent PCE inflation readings, implying that the Fed may have been closer to its 2% target than previously estimated. The most meaningful adjustments stem from changes to portfolio management and software-related categories, which should moderate the influence that the AI-driven surge in equity and software prices has had on the index.

However, this comes with a trade-off. By dampening the sensitivity of these components, the index may become less responsive to downside moves in asset prices. In the event of a correction, particularly if the AI rally were to reverse, the disinflationary impulse flowing through these channels could be more muted.

In short, the revisions may bring measured inflation closer to target, but they do not necessarily make underlying inflation easier to achieve or sustain at that level.

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Note: The accompanying podcast for this report will be delayed until later this week.

Asset Allocation Bi-Weekly – In Warsh, We Trust? (July 20, 2026)

Posted on by Amanda Ahne

by Thomas Wash | PDF

Newly appointed Federal Reserve Chair Kevin Warsh is pushing for a clear regime shift, starting with a complete overhaul of the central bank’s communications strategy. This month, he appointed a task force led by two former central bank heads — Mervyn King of the Bank of England and Arminio Fraga of the Central Bank of Brazil — alongside Peter Fisher, a former executive vice president of the New York Fed. Their mission is to address a core critique Warsh has held for years: Is the Fed offering markets too much forward guidance?

Central to the issue is Kevin Warsh’s longstanding contention that excessive reliance on forward guidance can erode the Fed’s credibility. He argues that giving markets highly detailed signals about the expected path of policy can constrain the Fed’s flexibility to respond abruptly when conditions change. In his critique, the Fed’s repeated characterization of inflation as “transitory” during the 2021-2022 surge illustrates this problem as it conditioned markets to expect rates to remain lower for longer even as price pressures intensified.

While it is easy to criticize, let’s not forget how we got here today. Forward guidance, as we understand it today, is a relatively recent innovation. Although the Fed has long sought to shape market expectations through its communications, a more explicit and transparent approach did not emerge until the aftermath of the Global Financial Crisis (GFC). Confronted with the most severe economic downturn since the Great Depression, the Fed recognized the urgent need to engage more directly with the public and financial markets.

Under Chair Ben Bernanke, the Fed introduced quarterly post-meeting press conferences — a decisive move toward greater transparency. This new communication channel was intended to help build trust and bolster its authority as the Fed undertook unprecedented changes in its operations, including the adoption of quantitative easing and a zero-interest-rate policy. The evolution continued under Chair Jerome Powell, who expanded press conferences to follow every FOMC meeting as he sought to help return monetary policy to its pre-GFC normal. In doing so, Powell further institutionalized forward guidance as a central policy tool.

The post-crisis monetary regime appeared to function reasonably well until the pandemic struck in 2020. In the years leading up to COVID-19, the Fed gradually lifted the federal funds rate off the zero lower bound toward a more neutral level, while simultaneously initiating a measured reduction of its balance sheet. This shift moved the system from a crisis-era framework of “abundant” reserves to one of merely “ample” reserves. Episodes of market turbulence (most notably the funding-market strains in 2019) were met with a so-called “mid-cycle” rate adjustment and renewed balance-sheet expansion, yet these responses remained firmly within the boundaries of the existing policy toolkit.

That trajectory was abruptly upended by the first global pandemic in over a century, prompting a nationwide lockdown and a coordinated push by the Fed and the federal government to inject liquidity and avert a prolonged downturn. The Fed rapidly scaled up its crisis‑era tools and leaned more heavily on forward guidance, while rolling out new facilities to stabilize markets and support credit to households and businesses. In doing so, it extended liquidity well beyond the banking system, marking a notable shift from its traditional focus on backstopping distressed banks.

As COVID faded, the Fed confronted a new challenge of resetting policy for an economy emerging from the pandemic. During the early recovery, it effectively emphasized the maximum‑employment side of its mandate over the inflation objective, fearing that the end of lockdowns would still leave many workers struggling to reenter the labor force after prolonged layoffs and amid deep uncertainty about the durability of the rebound. As price pressures began to build, officials judged that much of the increase reflected uneven reopenings and temporary bottlenecks, which they expected to unwind over time, an assessment that led policymakers to famously label inflation as “transitory” and signal that rates would remain lower for longer.

However, as the recovery progressed and labor demand began to outstrip supply, a series of exogenous shocks — from the Suez Canal blockage to major ransomware attacks and, ultimately, Russia’s invasion of Ukraine — amplified the inflationary impulse already fueled by aggressive fiscal and monetary support. With inflation running well above its 2% target, the Fed was forced into an abrupt and politically costly U‑turn, abandoning its lower‑for‑longer stance and launching a rapid tightening cycle.

The decision to tighten created major complications as the Fed was widely perceived to be behind the curve on inflation. This perception contributed to an unprecedented spike in bond volatility. In an effort to regain its credibility, the Fed sought to hike rates more aggressively by moving from 25 basis points per meeting to 50, and then to 75. This rapid escalation only fueled further unease, offering no clear signal as to where the upper limit might be. Such uncertainty triggered a sudden run on regional banks like Silicon Valley Bank, which had mismanaged duration risk by relying too heavily on the Fed’s forward guidance.

As inflation showed signs of easing, the Fed restored some of the credibility that its earlier missteps had called into question, not only regarding its previous decisions but also its ability to provide reliable guidance on the future path of interest rates. However, its decision to lower rates in September was largely viewed as political, despite the Fed having provided hints in the previous meeting that the committee was leaning in that direction, largely because the move came so close to the election.

This perception of political bias became a major theme in the lead-up to Warsh taking over as Fed chair, as critics began to view monetary policy decisions as favoring a particular party. While that claim is debatable, it nonetheless became one of the key reasons why Warsh has decided to undertake a major revamp of Fed culture, beginning with its communications strategy. His hope is that reducing the Fed’s transparency, among other changes, could help restore its reputation and bring the Fed back to its pre-GFC stature. So far, markets appear to trust that he is the right person to do it.

In Conclusion

While it is impossible to know what conclusions the task force will ultimately draw regarding the Fed’s current communications strategy, recent experience suggests that a reassessment may be warranted. All things considered, reducing the use of forward guidance could enhance the Fed’s credibility as it works to achieve its dual mandate of price stability and maximum employment. However, the effectiveness of this shift will depend on the degree and the way guidance is scaled back. If the Fed becomes more selective, offering forward guidance only when it has a high degree of confidence in its policy path, it could strengthen its reliability, while still helping anchor expectations and contain bond yields. By contrast, a more aggressive withdrawal, either by eliminating forward guidance entirely or withholding it during periods of heightened uncertainty, could introduce greater volatility in fixed income markets and place upward pressure on yields.

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Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify 

Asset Allocation Bi-Weekly – Are Long-Term Treasurys No Longer a Safe Haven? (March 16, 2026)

Posted on by Amanda Ahne

by Patrick Fearon-Hernandez, CFA | PDF

Historically, major geopolitical or economic crises, such as the war against Iran, have prompted investors to sell riskier assets and buy “safe-haven” investments whose values were expected to remain stable or even rise amid the disruptions. The most popular safe havens have been the US dollar, gold, and longer-term US Treasury obligations. Faced with the crisis, or the prospect of one, investors would typically bid up the value of the dollar versus other currencies. Many would also avidly buy up gold, driving prices for the precious metal upward. Others would snap up Treasurys, boosting their values and pushing their yields down. However, market action so far during the Iran war has defied expectations. Treasury demand has been relatively muted, and yields have been markedly resilient. This raises the question of whether long-term Treasurys are still a safe haven. And if not, why?

One way to see the unusual performance of long Treasurys is to compare their recent total returns versus shorter-term Treasurys. In the chart above, we show the total return (price change plus interest) for exchange-traded funds (ETFs) tracking Treasury obligations maturing in 20+ years (TLT), 10-20 years (TLH), 7-10 years (IEF), 3-7 years (IEI), 1-3 years (SHY), and 0-1 year (SHV). The graph shows how Treasurys of all tenors were bid up starting in mid-February, when it became clear that the US was prepping for a potential strike against Iran. However, once the war started, investors sold off Treasurys. The selling was especially strong for long-duration obligations as investors began to realize that the conflict could be more drawn out than anticipated, driving up global energy prices and rekindling consumer price inflation.

Importantly, the outsized selling of long Treasurys came after a protracted period of weak returns. The chart above displays Treasury total returns by duration over rolling one-year periods. It shows clearly how one-year returns from long Treasurys have lagged since early 2025.

Indeed, long-term Treasury returns have lagged for quite some time. The final chart, on the next page, shows that three-year returns for long Treasurys have not only lagged shorter-term Treasury returns, but they have also lost money in the latest three-year period. This happened even though the Federal Reserve has been cutting its benchmark fed funds interest rate since September 2025. In contrast, shorter-term Treasury securities have offered steady positive returns. Shorter-term Treasurys have largely held their value even after the Iran war started and it became clear that the conflict would threaten global energy supplies and risk reigniting inflation.

Why have long Treasurys lost their attraction as a safe haven? We believe their weakness reflects increased investor concerns about US fiscal dynamics, prospects for a more politicized Fed, and fear of currency debasement. The key evidence for this has been the sell-off in long Treasurys after the war started, once it became clear that the conflict could last long enough to seriously disrupt energy supplies and cause rising global inflation. If investors were truly confident that the Fed would temporarily hike interest rates as needed to wring the inflation out of the economy and protect the purchasing power of the dollar, then demand for Treasurys should have gotten a boost from wartime safe-haven buying. However, the fact that Treasurys have not behaved as usual suggests they may have lost a lot of their cache as a safe haven. As investors also sell off gold to cover margin requirements and raise needed cash, it seems like they only see one true safe-haven asset these days, i.e., cash.

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Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify 

Asset Allocation Bi-Weekly – White House vs. The Fed: The Looming Battle for US Monetary Policy (May 19, 2025)

Posted on by Amanda Ahne

by Thomas Wash | PDF

The Federal Reserve’s independence faces its most serious challenge in decades as the Trump White House escalates its criticism of central bank policy. This brewing confrontation echoes historic tensions — most notably the 1951 clash between President Truman and Fed policymakers over yield caps that ultimately led to the Treasury-Fed Accord. Today, the battle lines are being redrawn as the administration pushes for more accommodative monetary policy while it looks to shield the economy from its own trade war.

The widening policy gap between the Fed and its global peers has been highlighted in recent months. While the European Central Bank, Bank of England, and the People’s Bank of China have all lowered their benchmark short-term interest rates to combat slowing growth, the Fed has held its benchmark rate steady — a decision repeatedly criticized by the White House. This policy divergence is further strained by the Fed’s quantitative tightening program, which Treasury Secretary Bessent argues complicates the issuance of longer-term government securities.

The debate has now moved beyond short-term policy disagreements to fundamental questions about the Fed’s role and independence. Former Fed Governor Kevin Warsh, widely seen as the leading candidate to replace Chair Powell when his term ends in 2026, has emerged as a vocal critic of the central bank’s current direction. His critique focuses on two key concerns: first, that the Fed has strayed beyond its core mandate by engaging in issues like climate change policy and diversity, equity, and inclusion; and second, that its operational approach — particularly the frequency of public commentary by FOMC members — has created unnecessary market uncertainty.

Market participants are closely watching several potential flashpoints. The administration has reportedly considered accelerating the leadership transition by nominating Powell’s successor well before his term concludes, a move that could allow markets to price in policy changes gradually. Warsh’s combination of Republican credentials, Fed experience, and Treasury background makes him the probable choice, although some investors question how his well-documented hawkish views might align with the administration’s apparent preference for easier monetary policy.

The stakes for investors are significant. Any perception of compromised Fed independence could trigger a reassessment of risk premiums across asset classes. Treasury yields may face upward pressure, particularly at the long end of the curve, while the dollar could weaken if markets question the central bank’s commitment to price stability. In other words, concerns about reduced Fed independence could exacerbate the budding US capital flight that we discussed in our recent Asset Allocation Bi-Weekly from May 5, 2025. Perhaps most critically, the Fed’s ability to serve as a stabilizing force during future economic downturns could be diminished if political considerations are seen to influence its decision making.

As this drama unfolds, market participants would be wise to monitor three key developments: the timing and nature of any leadership transition, changes to the Fed’s communication strategy, and, most importantly, whether the central bank can maintain its operational independence while navigating increasingly choppy political waters. The outcome of this power struggle will shape monetary policy and market dynamics for years to come.

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Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify 

Asset Allocation Bi-Weekly – Tackling Long-Term Interest Rates (March 3, 2025)

Posted on by Amanda Ahne

by the Asset Allocation Committee | PDF

In his testimony before the House Financial Services Committee on February 12, Federal Reserve Chair Powell was questioned about why mortgage rates had not declined. In response, Powell emphasized that the Fed primarily influences short-term interest rates, not the longer-term rates such as those tied to mortgages. Despite the central bank cutting its benchmark short-term interest rate — the fed funds rate — by 100 basis points since September 2024, the average 30-year fixed mortgage rate has risen by about the same amount, highlighting a disconnect between the two.

This apparent discrepancy stems from the fact that most interest rates are closely linked to movements in long-term US government bond yields. While average short-term rates, which are largely influenced by the Fed, have remained relatively stable in recent months, the yield on the 10-year Treasury note has picked up.

This widening gap between short-term rates and long-term rates, often referred to as the term premium, is an important element for understanding today’s interest rate dynamics (the chart below shows the San Francisco FRB’s estimate of the term premium, which uses expected short-term rates versus the 10-year Treasury yield). The growing gap signals that investors are not relying solely on the Fed’s guidance when valuing assets. This may explain why Treasury Secretary Bessent has emphasized that the administration will focus on reducing 10-year Treasury yields rather than pressuring the Fed to lower its policy rate.

Closing the gap between long-term and short-term interest rates over the next decade will likely be crucial for the administration to reduce borrowing costs effectively for households. This gap represents the premium that investors require to offset risks such as rising bond supply, inflationary pressures, and potential default concerns. To address these challenges, policymakers have proposed a mix of conventional and unconventional strategies.

One conventional approach the administration has taken to help reduce longer-term rates is addressing the US debt problem. The incoming administration has focused on trimming government staffing, reviewing payment systems, and proposing budget cuts to social programs as well as potential cuts to defense spending. On the revenue side, proposed measures include closing tax loopholes, such as the carried interest deduction and special tax breaks for sports teams, while also introducing tariffs to generate additional income.

Additionally, the Treasury has explored alternative methods to manage the 10-year Treasury yield through strategic debt management. One approach involves reallocating Treasury issuance toward shorter-dated bonds, mirroring strategies used by the previous administration. Another proposal includes issuing 100-year “legacy bonds,” potentially targeting foreign governments under the threat of tariffs, as a way to diversify funding sources and stabilize long-term yields.

The administration is also exploring regulatory changes to boost the attractiveness of US bonds.  One key proposal would exclude US Treasurys and reserves from the calculation of the supplemental leverage ratio (SLR), which affects bank capital requirements. Excluding Treasurys from the SLR calculation could potentially drive significant bank demand for the obligations. This proposal builds on previous precedent, such as the ’temporary suspension of SLR limits during the pandemic, which aimed to improve market-making capacity and support Treasury values.

The Fed could also support the administration’s efforts in two key ways. First, it could signal a willingness to lower the federal funds rate, which would likely boost demand for Treasury bonds. Second, the Fed could pause its balance sheet reduction or begin bond purchases, which could help ease the current supply imbalance in the bond market. While such actions might appear controversial given the Fed’s traditional independence, it is important to note that the two institutions have a long history of maintaining strong communication and coordination when necessary.

In sum, long-term government bond prices could see a modest rise over the coming months, driven by the policies of the new administration. Longer-term Treasury yields could therefore fall, as we projected in our 2025 Outlook. This would likely lead to lower borrowing costs for everyday households, including reductions in mortgage rates, auto loans, and credit card interest rates. However, while the measures discussed above may help compress the term premium, a meaningful decline in long-term yields will likely require a further reduction in short-term interest rates.

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Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify