Richard Clarida is with us, with Pimco, of Columbia University, always and always, the vice chairman and former vice chairman, I should say, of the Federal Reserve System. And I think, you know, we're going to straddle here between Bloomberg Money and everything else. Yeah.
And we got to start with what we saw in the bond market this week because we had a selloff, and the 30-year yield this week reached a 19-year high, 5.26%. Rich Clarida, does the selloff in the long bond tell us anything about the U.S. economy and therefore how people's prospects might change?
Well, there are a lot of reasons bond yields can go up and down, not just the Fed. The Fed's an important part of it. What I would point to is that so far, Kevin Warsh has been chair really only six or seven weeks, but an important measure in the bond market, which is break-even inflation — so sort of traders' expectation of inflation — is at or below where it was at least after 10 years when he became chairman. But certainly the reaction during the press conference was probably not one that was welcome. Right.
We know the first Trump administration cared a lot about the stock market, and the second one seems to have added the bond market to its list of things that it's watching. Which part of the bond market does the administration care most about? The 30-year yield? The 10-year yield?
Oh my goodness, I'm not sure. I would defer probably to Secretary Bessent. I do think at one point he may have said that he's focused more on the 10-year yield than he is on the fed funds rate. Well, so much of the economy — people borrow long for car loans or mortgages or corporate loans — and so that's probably what he had in mind here.
So what we're going to do here, it's Bloomberg Money. We do personal finance, we do wealth management, we do retirement. But we also have Richard Clarida, where this is in the heart of this debate over the chairman of the Fed. So it's going to be a little bit sort of like Scarlet Fu and Tom doing Bloomberg Surveillance, like more. You can protect the children. The lines are blurry. Protect the children at home. Yes.
Okay, so the former vice chairman, with great respect, I don't want to turn this into a history lesson, but you have Warsh, nominally of Stanford, talking about the Lucas critique. Yeah. And then going over, and what people don't know is you're directly involved with this. Let's first listen to Chairman Warsh on Wednesday.
Some version of the Lucas critique should remind us that when we talk about measures of inflation or something else, and we describe those measures as being consistent with our objectives, we might make them such that they're not very good measures or very good objectives.
The chairman, before he had the questions from Michael McKee of Bloomberg, the world lit up, and along with Leijonhufvud out of Lucas's Chicago, was fiery. The news conference was rich in philosophy, process and institutional aspirations, but poor in operational guidance. The absence of clear analytical specificity appears to have spoken louder than Warsh's words.
So Lucas did what he did. Kydland and Prescott, and Gali and Gertler reinvented modern economics with something called dynamic stochastic general equilibrium theory. We come out now, and as Claudia Sahm says, we have a chairman who is not sure what he's looking at in inflation. How does he get the barrels back on? Does he need to reaffirm PCE? Is the inflation serious?
Well, I think what he said at the press conferences is, for now, until next January at least, that's going to be correct because the Fed adopted that again in January. He left open the possibility that the task forces could recommend other measures. They could go to an average instead of picking one index, they could look at CPI, PPI. There are a lot of things they could do. But I think Aaron, as usual, raises an important point: is that an inflation-targeting central bank needs to be clear about what it is it's targeting. It can and may evolve. And so I think that will be important.
Very, very importantly then here, if we need to get the system back with confidence about the Fed. Yeah. How does he do that at Jackson Hole? Does he have to reaffirm, as Sahm says, that PCE is the appropriate measurement and not a policy?
Well, I think Jackson Hole may serve a couple of purposes. Historically, as we've seen, chairs have used Jackson Hole as sort of a sneak preview of coming attractions at the September, November and December meetings. Chairman Warsh, he may do that. He's also interested in what he calls some big question, big picture questions that he sort of previewed at this meeting. And he's also talking to the task forces. So I think it's too early to tell what he'll do at Jackson Hole, but he may, he may do that as well.
Yeah, I find it really interesting that he doesn't want to tell the bond market a whole lot of things, and he's kind of waiting to take his cue from the bond market. From a layperson point of view, it feels very circular. Right. The central bank sets a benchmark interest rate, the bond market takes its cue from that. What's the rationale for the Fed to take its cue from the bond market that's relying on the Fed to set policy? Help me understand that.
So, so here's the way I would express it. The Fed is a very important part of the 10-year Treasury yield. It's not the only thing that drives yield. So I think the chairman was important to emphasize that the Fed does want to step back and interpret movements in bond yields. It could be inflation, it could be global growth, Middle East hostilities. But certainly the chairman and the Fed understands that an important part of 10-year yields is the expected path of the funds rate. And to Scalia's point, and I actually, Ben Bernanke gave a speech on this, as did I as vice chair. It's called, sometimes called the Hall of Mirrors problem in central banking, which is the central bank looks at the market, the market looks at the central bank. It gets circular.
Let's go back to your paper. Gali and Gertler didn't know this. Richard Clarida channeling Alan Blinder, having looked at monetary policy from Joni Mitchell's Both Sides Now. I can testify that central banking in practice is as much an art as a science. How does Warsh get back to science, to Clarida, to silence versus some mom-and-pop philosophy you learned at Stanford?
Oh, well, I think Kevin Warsh and that committee understand that. Look, Kevin came in, Chairman Warsh came in with an ambitious agenda, and I think that they're going to both focus on implementing that agenda as well as getting to where they need to be on policy. I guess where I would try to relate Clarida to Gali-Gertler to the current conversation is perhaps specifically in the domain of forward guidance. And so in the CG model, there's actually not a role for forward guidance because the market understands the Fed's reaction function and the Fed understands the market. If you're not going to do forward guidance, then it's incumbent for the markets to have a broad understanding of how the central bank will react to data. If we had six bad months in a row of inflation data, would they hike and by how much? They're not committing to that, but they're saying if the data comes out this way...
...for everybody on Bloomberg Money. And so I got goosebumps. This is like the real deal. I mean, this is what the adults in the room are arguing about right now.
