The Dividend Cafe - Everything We Learned about the New Fed This Week

Episode Date: July 31, 2026

Today's Post - https://bahnsen.co/4wwsHI5 David Bahnsen reviews this week’s Fed meeting, noting some credible forecasts expected a surprise 25–50 bp hike, though the Fed ultimately held. He argues the Fed’s rationale was unusually direct: financial conditions tightened without a hike as yields rose across the curve, and further tightening should prioritize stopping balance-sheet expansion after $200–$250B of added assets this year. Bahnsen contrasts camps calling for hikes because inflation has stayed above 2% with those citing falling TIPS-implied inflation expectations near 2%, while emphasizing Warsh’s market-focused approach and opposition to investors “gaming” Fed guidance (“play the ball, not the referee”). Warsh rejects a Phillips-curve tradeoff, saying price stability and full employment are not in conflict and inflation harms labor markets. Bahnsen expects falling hike odds and is skeptical rates rise this year, viewing Warsh as reform-minded but incremental, independent from President Trump despite citing tariffs and oil-driven supply shocks. 00:00 Welcome and Setup 00:36 Why This Fed Meeting 03:36 Case for Rate Hike 05:12 Fed Transparency Shift 08:22 Markets Tightened Already 10:21 Balance Sheet First 14:11 Warsh Philosophy Shift 16:50 Hike Odds and Outlook 17:55 Independence and Politics 20:47 Closing Takeaways 22:44 Sign Off and Weekend Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividing Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to this Friday's Dividend Cafe. I'm your host, David Bonson. We're going to be talking about the Fed today, but it's going to be very fun. It's not going to be a regular monetary policy talk where I'm going to lose you with the minutia boredom of federal open market operations and other such things. I want to get into what happened this week with the Fed. I want to explain why I chose to talk and write about it this week and really lay out some concrete thoughts about the very short-term future with the Fed and longer term. I think it's an incredibly important topic right now.

The reason, by the way, that I basically chose at the very beginning of the week, this topic for today's Dividend Cafe was that I was very open to the positive. Although it was not my base case and I expressed time and time again a lot of skepticism that this would happen, but it was one of the first Fed meetings I can remember in a long time where there was a part of me that wondered if I would be surprised. And some of that potential for surprise. You can't say you expected to be surprised because that doesn't make any sense. but why I was predominantly expecting the Fed to do exactly what they did do, but open to the possibility that I was wrong, is that there simply were other people who I hold an extremely high regard

who were really quite convinced that the Fed was going to do something, somewhat surprising, namely hike rates when it really wasn't baked in. And a quarter point rate hike this week would have been a surprise to markets, But the futures had it at about a 30% implied probability. 30% is not zero, but it's obviously not the majority case. But several folks were very confident that you could see 50 basis points, basically two quarter point rate hikes. And that would have been extremely surprising to markets.

And their argument was not just why they thought they ought to do it. it was primarily in the vein as to why they thought they would do it. And there was something compelling about the case. Now, again, it wasn't my argument. And as it turned out, it was most certainly not what ended up happening. But I want to walk through some of this. And I want to explain to investors. I want to explain to anybody reading or listening that doesn't think they care or need to

care about what the Fed is doing or going to do. Why we are in what is a really, really different point. in my opinion, in history, that as someone who has followed the Fed so closely, not just for my adult life, which at this point is not exactly a small period of time, you're talking about covering some remarkably historical periods of time in my, let's call it, 35 years of adult life. But I would say that even prior to that, in the decades before I, I came of age, that there has been a number of periods of cycles of events with the Fed, with the role of the Fed plays in the economy.

And we are right now at a point where there is opportunity for a very big difference in the Fed's relationship to markets in the economy. And I believe it's important for us to understand this the best of our ability. So the base case for a hike this week, not just those predicting that it was going to happen, but that even right now really believe the Fed should have is a pretty simple syllogism. It's essentially the Fed says their inflation target is 2%. Inflation has been over 2% for five years, four years, wherever you want to start it. So therefore, they ought to raise rates.

That's a pretty logical construction. And a pretty simple case. Now, of course, there are reasons why there could be flaws in that argument. Someone could counter and say, well, the inflation rate is headed to 2%, even if the Fed doesn't cut. And they can be right or wrong about that, but that might change the validity of the prior argument or the prior case I relayed. Some may say that the factors keeping the inflation rate above 2% are not addressed in a higher interest rate. Some may say that there are other things we could do. They would be more effective in reducing the inflation rate.

And I think that probably there are plenty who would say, well, the cost of running inflation above 2% is less than what the cost would be if they were to raise rates in terms of unemployment or something like that or just economic contraction. I'm not saying that any of those things are necessarily true. true, but it points to why the base case for a rate hike does have some more complexity and nuance around it. Now, what is most fascinating is that we are in a period of time where sometimes folks get the right argument for the wrong reasons, or at least for different reasons. I don't want to poison the well by saying necessarily right or wrong, but not everything is aligned

just because the conclusion gets the same. The reasons that get there matter a great deal. And the Fed has made this very complicated because it's hard for us to have debate when sometimes you're debating something that's disingenuous. So, for example, I have spent the greater portion of the last 18 years wanting to debate and argue against the wisdom of the 0% interest rate policy that has been in place for the majority of those 18 years. and yet, if I argue it on the Fed's public terms, then I'm making a big mistake because the Fed, I don't believe is being fully transparent or honest about the real case. If they say we want zero percentage of straight because we think in 2015 or 13 or something, and the reason is that we believe unemployment is just going to go too high if we don't. Well, then you end up having an argument about it and you want to argue what interest rate policy should be.

But if their real reason is they're worried about dollar liquidity in emerging markets, if their real reason is that they're worried about government cost of capital because deficits have exploded, if their real reason was that they wanted a more robust housing recovery before they messed with interest rates, they may or may not be wrong or right on all of those things, but that wasn't what they ever stated. And so we have a situation where time and time again, I believe the Fed from their balance sheet to interest rate decisions has created a public debate that is fostering disingenuous conversation because people are debating the outcome of what the Fed has done on the basis of the reasons the Fed has stated they've done it. And I don't think

think the Fed has been completely straightforward all the time. And I think that right now, what you saw this week, whether you agree with it or disagree with it, was very straightforward. I think that the Fed was telling you why they were doing what they're doing, why they were not doing what they're not doing, and that there was a pretty remarkable amount of honesty behind it. And so it enables us to then kind of say, okay, again, we're free to disagree with it, but at least we know what we're discussing, all right? We know what the rules of engagement are. I think that the base case for the Fed not raising rates has some compelling arguments in it,

but I do not think they were the same arguments that the Fed made this week. And so that's where this gets a little bit tricky, is sometimes people are agreeing or disagreeing with the outcome and other times they're agreeing or disagreeing with the reasoning for the outcome. And I want us to unpack that with a lot of specificity and clarity, okay? The Fed basically did not make this argument, which is, yes, we want inflation down to 2%, but we think it's getting there anyways. However, there are plenty who might say, and I'm going to put a chart up right now if you don't mind showing the tip spreads. This is essentially implied inflation expectations, two year, five year, and 10 year.

And you see all of it has moved down as of late and all of it is getting pretty close to 2%. This is trillions of dollars of market actors that are with one of the great pricing mechanisms in financial or capital market history, the tip spreads that enable us to look at implied inflation expectations, getting near, not at the 2% target on their own. It's a strong market indicator. And so, again, there are folks who would say, why add medicine to something that's getting better on its own? And that's a fair argument structurally.

I happen to think that what the Fed said this week, even though they got to the same outcome, which was we don't want to raise rates right now, but we're willing to do if we think it's necessary to get inflation to 2%, was that they believe the tightening that would help in financial markets took place without them having to, that across the yield curve from the short end to the long end, in both real rates and nominal rates, you saw a meaningful move higher, over 20 basis points of movement just since the last Fed meeting. So they would argue and not without facts on their side that you got tightening without them having to tighten. And this is a theme in what Chairman Warsh was saying and doing this week and has been since he took the chairmanship, that markets are a much more important indicator to him than projections.

speculation. Now, the other piece to it that was barely really spoken this week, other than some nods and some very rough references, but I think is very much at the core of Chairman Warsh's thinking is, if we want to tighten monetary policy and we have added $200 to $250 billion to our balance sheet this year, why would we cut rates when we could at least first start with turning off the spigot on the added liquidity in the financial system via bond purchases, the asset purchases under the Fed's balance sheet. And it's a perfectly legitimate argument. Now, why didn't he come out and more explicitly unpack and say it this week? Because he appointed a task force that's looking at the impact of balance sheet activity. And I think the chairman believes it would be

inappropriate for him to get in front of what the task force may or may not end up saying in the end. So he was reasonably reserved about it. But I think he's done a great job at already making clear how he feels about it. I love this analogy I used in the written Dividing Cafe this week, that continuing to have this excess accommodation of balance sheet activity and talking about raising interest rates would be like saying, maybe we need to go install this massive security system at our home before you've even tried shutting your front door and your back patio door,

let alone locking it. There's just sometimes lower-hanging fruit available if that's really what the objective at hand might be. And so I don't think that Chairman Warsh is a dove, and in fact, I don't think he's really a hawk either. I think that those that labeled him are labeling him a dove right now are wrong, and I think those that believed he was coming in as a hawk are wrong. I think he's governing from a set of principles

that many disagree with. But he believes, and I happen to agree with him, that the Fed should not be giving guidance whereby folks are making financial and economic decisions and engaging or not engaging in activities based on what they believe the Fed will or will not do. And so this analogy that he's used, we're going to talk about in a second.

Let me wrap up the balance sheet thing first. There's a chart I want to put up real quick just to show you this $200,000. $250 billion added to the balance sheet. You could argue that if that line that you see having moved diagonally up over the last four months were flat, it's entirely possible he would have voted to hike this week. I just simply think he says, look, if our goal is to tighten a bit to help with our inflation mandate and encouraging and fostering price stability, then look at this chart for a tool of what

we have available and that may be a more useful tool at this time than hiking the rates. So again, I'm totally open to the fact that some may disagree, but I think it's a legitimate argument. So in summary, you could say when you look at the different camps of what people are thinking right now, that there are hawks who believe the Fed should hike because we're above the target inflation rate. And there are others who believe we should not hike because we're headed there anyways. And then there's Chairman Warsh's view or the majority of the Fed that seems to believe we do need to tighten, but markets are doing it for us.

And if markets are doing it for us, why intervene? You have higher real and you have higher nominal. Let's allow those things to play out. And in the meantime, stop with the asset purchases. Okay. So those are the different camps that are out there now. Well, that's what's taking place. So that is what it is.

The question, I think, for us as investors and trying to make sense of where it's all going is what this regime actually looks like. And when I hear people say after six weeks, okay, Warsh is just turning out to be another one of the same old, same old. I do not agree. The theme he used in the press conference that we've now heard more and more that I think is going to become a major figure of speech around a lot of this is playing the ball, not the referee.

And whether or not you love how the analogy captures it. the underlying point is a very, very good one and a very important one. I have lived through a period of significant amount of financial activity that was not about producing goods and services and innovating and creating. It was about trying to game what the Fed may do. And it is not productive and it is not additive. It's essentially people trying to win in a zero sum contest versus going out and doing something that's not zero sum that builds into economic growth.

So there's a more efficient allocation of capital and also more prosperous outcomes in a higher standard of living that result when people are focused on the productive. And I think that Chairman Warsh's philosophical commitment to this idea is really, really genuine and very important and very new at the Fed. So that play the ball not the referee theme is an important one. But then this idea, I've talked about Phillips Curve, people look at me with eyes glazed over, but the general idea that people believe inflation and jobs are in this tension with one another.

And Nick Timmeros, who is the Fed writer and watcher at the Wall Street Journal, and he was very, very close with Chairman Powell. And he somewhat confrontationally asked Chairman Warsh yesterday, what is your mechanism? what is the transmission mechanism going to be for managing the trade-off between price stability and full employment? And Warsh said, and I want to quote them word for word here, price stability and full employment are not at war. I do not accept that these things work against each other. In fact, I believe the most harm done to labor markets is caused by high inflation as price uncertainty impedes hiring, investment, risk-taking, wage growth, things like that. This is the economic approach that I've been preaching for my whole career. And so to hear the Fed chair actually say it, I think represents a major paradigm shift from where we've been.

Well, where are we now? The odds of a rate hike were about 95% by September, and now they're down to 63%. And I suspect that you'll see those futures expectations go even lower. They were 100% that we'd have a rate hike by the end of the year. They're now at 84%. So again, you still have. a predominantly majority view that there's some rate height coming, but it's lesser so than it was. And that majority may be right here. They may very well. But if you get reports in the next four to

six weeks suggesting that jobs are weakening or that prices are stabilizing, if you get the opposite, that jobs are really struggling and the prices going the other way, like I just believe that there is going to be a refresh of where they go around the reality of data that they have. And I'm very skeptical that they will end up deciding to raise rates this year. But I don't believe that that is because they're being overly doveish. I think that, look, some of the arguments that Chairman Warsh, in particular, could have just killed the narrative that he's doing the president's bidding. and he could have established a real premium around Fed independence

by just shocking markets of the 50 basis point hike. That's entirely true that he could have done that, and it would have had that effect. But that effect would have come at an unbelievable cost. And so you could call it playing it safe, but when people say, hey, I thought we were getting a new kind of Fed share, if this just seems like more of the same, I would suggest that it's very possible

an institutionalist like Warsh is a reform-minded Fed chair who just doesn't believe in coming in with the bazooka. That there's an incrementalism. He's appointed task force to approach some of these key areas about data, about the balance sheet, about the Fed's reaction function, that he maybe incrementally is going to be looking at stopping the expansion of the balance sheet before he looks at rate hikes. and it's entirely possible that he is who we thought he was in terms of reform-mindedness, but he doesn't equate that with big moves quick, that he wants to be more of an incrementalist. And I, for one, find that to be very consistent with institutional credibility and conserving a certain sobriety and judgment in our nation's central bank.

So, no, I don't think any of this has anything to do President Trump whatsoever. I will point out that he was explicitly and somewhat shockingly critical in how he said one of the price inputs are dealing with us, the impact from tariffs that are running up prices and goods and that you now have this really big supply shock and volatility premium because of oil prices, calling out the two most unpopular things in the current administration, which is the Iran War and the tariffs. And so for the chairman to call it out, it isn't like he said President Trump's name. It isn't like he was coming out saying these are horrible policies, but he was alluding to the causation that they have in a negative context. I don't think that he was in any way,

shape or form acting as a sort of lackey of the president. I think that he will do things that the president likes, but not because the president likes him. And he will do things that the president doesn't like and he won't be doing it because the president doesn't like it. I think that's what we're supposed to mean by the word independence. At this point, I still remain confident in that. So in conclusion, I think it's good that we don't have a revolutionary Fed chair. I think it's good we have a measured one. I think that there are legitimate reasons to suggest for a rate hike. I think there were very legitimate reasons to not do one. And I think of the reasons to not do one, Warsh's stated reasons about market response, market function, and balance sheet precedents, the balance sheet

being kind of first in the priority of policy tools to use, I think was a very compelling argument. And there's going to be a lot more to chew on. The Fed has to deal with PCE data. They have to deal with the oil price volatility. They have to deal with tip spreads and ultimately do something that many Fed chairs have had to do for many decades that is a more nuanced mandate than people realize when you start talking about the dual mandate of full employment and price stability. But he is doing this with a governing framework and a philosophical foundation that is very different in not believing those things are at odds, prices and jobs, and in his belief that the Fed should not have this major footprint in the economy that they

become the game. He wants them to be the ref and wants us to make our economic decisions on what's happening in the game itself. If it sounds like I'm being a harsh cheerleader, it's because I'm calling it how I see it this far. I assure you, if this man lets me down, It is not going to be the first person to let me down in my adult life in the public policy framework. And it will not be the first time I have to call someone out who I had higher expectations for. But right now I remain cautiously optimistic that we have the right governing framework within the bounds that exist here at the Fed. And I think that this is a really unique opportunity for investors to potentially see some resets in this reform endeavor that I think are going to be very constructive. I'm going to leave it there. Thanks as always for watching, listening and reading the Dividing Cafe.

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