By Michael S. Derby
Aug 20 (Reuters) - Two Federal Reserve officials expressed caution on Thursday when asked how the Treasury Department's debt management changes could affect the U.S. central bank's monetary policy choices.
"We focus very simply on the labor market and on inflation, independently set monetary policy, independent of debt management or fiscal policy," St. Louis Fed President Alberto Musalem told CNBC when asked about Treasury's decision on Wednesday to shift to a more aggressive pace
of buybacks of longer-term government debt.
Long-term Treasury yields recently spiked on concerns about the U.S. government's rising debt, inflation that remains stubbornly above the Fed's 2% target and the implications for investment flows.
The impact of Treasury's intervention appeared short-lived, as yields rose again on Thursday after dropping sharply on Wednesday.
Speaking separately to CNBC on Thursday, Treasury Secretary Scott Bessent said part of the push for a bigger buyback is about signaling that "yields don't reflect the underlying fundamentals" of the economy.
The intervention creates potential challenges for the Fed because of the possible confusion in financial markets as to which institution is the main driver of financial conditions. While easing financial conditions, all else being equal, Treasury's move could lead to friction with a Fed that may yet raise rates to help cool inflation.
Bessent on Thursday downplayed any conflict and said any Fed rate decision is completely separate from what the Treasury is doing. And in terms of anything that might impact the U.S. central bank's balance sheet, the two institutions “would work together if there was any change in the (Fed) balance sheet, and we ... would adjust to any kind of runoff (of bonds) that they're doing," the Treasury secretary said.
If financial conditions are now supportive of economic growth and not working to lower price pressures, Treasury's intervention, to the extent it engineers a sustained drop in yields, would move markets even further from where the Fed would like them to be. And that scenario would in turn bolster the case for raising the central bank's benchmark interest rate.
Musalem, who thinks the Fed should have raised rates rather than kept them steady in the 3.50%-3.75% range at its July 28-29 meeting, suggested he was leaning toward a hike at the September 15-16 meeting. He noted that "financial conditions are pretty accommodative here."
'THESE ARE EARLY DAYS'
Speaking to Bloomberg Television, San Francisco Fed President Mary Daly said current long-term bond yields do not "give us a lot of signal about what we should do in the policy adjustments or the policy calibration for the Fed."
Daly said she thinks Fed policy is a "good place" while adding that she's watching longer-dated bonds to see what they imply for the outlook. She noted that she strongly supported the Fed's decision to leave rates unchanged last month.
Asked whether a shift in Treasury debt issuance to more short-term debt could create issues for how the Fed conducts monetary policy, she said, "These are early days, and I wouldn't want to be preemptive in sort of discussing those types of things until we've had a chance to think through those issues."
More issuance at the front end could put upward pressure on market rates, creating technical challenges for how the central bank manages interest rate policy. The Fed's rate-control system depends on influencing money market conditions to manage interest rates by way of a series of tools and liquidity facilities.
Daly added that the key issue for the Fed is less about the "mechanics" of how it achieves its inflation and employment mandates than its commitment to do so and ability to achieve them.
(Reporting by Michael S. Derby; Editing by Chizu Nomiyama and Paul Simao)
