How markets are calling Fed's bluff: Ex-Fed gov

The markets have been "absolutely spoiled by the Federal Reserve" and its accommodative monetary policy since the depths of the 2008 financial crisis, former Fed Gov. Kevin Warsh said Tuesday.

"Now, I would say the markets are exhausted. They're exhausted that the Fed has decided there's a new set of benchmarks," he told CNBC's "Squawk Box" in an interview. "Before it was forward guidance. Now it's, 'Just kidding about forward guidance.'" Citing the sliding unemployment threshold for considering an interest rate hike, he said it's now 5.5 percent or even 5 percent, down from 6.5 percent not too long ago.

The financial markets have Fed Chair Janet Yellen's number, Warsh said. The "taper tantrum" back in the days of quantitative easing bond purchases and now the "dollar tantrum" ahead of possible rate hikes each forced central bank policymakers to reconsider their timing. "This is a very dangerous development," he argued, with the tail wagging the dog.

Warsh, a distinguished visiting fellow at the Hoover Institution, was a Fed governor from 2006 to 2011. He was appointed by President George W. Bush.

The inflation excuse for not rushing into rate hikes is not sound, he said. "The reality is inflation is not a problem;" it's not too low.

He said core inflation, which excludes the volatile food and energy components, is running at about 1.5 percent—only slight lower than the Fed's 2 percent target. "What's the difference to the real economy?"

"I don't like policies that are being changed based on what's happening on our ticker machine," Warsh said. "The Federal Reserve should be focused on what's happening three or four years out," not recent data that's been skewed by harsh winter weather.

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