Federal Reserve Chair Kevin Warsh heads into his first Jackson Hole speech with an extremely difficult task in hand! He has to convince markets and the US audience that the central bank is serious about bringing inflation back to 2% without adding fresh pressure on the bond market, which is already showing signs of strain.
Markets raise rate-hike bets as inflation remains above target
The timing could not have been more complicated.
Currently, the inflation remains much above the central bank’s original target. The Personal Consumption Expenditures Price Index, which the Fed uses to set its target, increased 3.7% in the 12 months through July, the Commerce Department’s Bureau of Economic Analysis said on Wednesday. These numbers raised expectations that the Fed is likely to hike rates in September.
Traders now see a 40% chance of an interest rate hike next month, compared to 36% before the data, and are pricing in a 60% chance that the Fed will leave rates unchanged, according to the CME FedWatch Tool.
That puts Warsh in a delicate position.
Bessent’s bond-buying push adds pressure to Warsh
The other bone of contention for him is long-term Treasury yields, which have climbed sharply in recent weeks, raising borrowing costs. The 10-year Treasury yield was around 4.65% on Wednesday, while the 30-year yield remained above 5%.
Warsh has a clear stance regarding this. He pointed out that the central bank, having established a large footprint in markets by snapping up government bonds and mortgage-backed securities during past crises, has distorted the pricing of financial assets.
But the US Treasury’s own response to the bond-market pressure has complicated the problem. Treasury Secretary Scott Bessent has doubled the size of planned long-term bond buybacks and has indicated that the government could intervene with even larger amounts. The move is intended to support Treasury prices and lower long-term borrowing costs.
This created an awkward policy clash. The Treasury wants lower long-term yields, while the Fed needs financial conditions to remain sufficiently tight to bring inflation down.
At the most basic level, Bessent has raised the stakes for Warsh this week, Michael Strain, an economist at the conservative American Enterprise Institute, told the New York Times.
“It makes it more important than it already was that Chairman Warsh clearly communicates his views of how the economy works, the trade-offs that the economy faces and the Fed’s role in markets,” he said.
Warsh has also broken with the Fed’s recent tradition of offering extensive forward guidance. Rather than telling investors exactly what the central bank will do next, he has preferred to let markets interpret incoming economic data. That has left investors hungry for clarity ahead of his Friday speech.
“You won’t accomplish anything if you are unwilling to tell people how you think the economy works,” Anil Kashyap, an economist at the University of Chicago’s Booth School of Business, told the NYT. “You have to have a mechanism that you think explains why if you’re going to do something differently, it’s going to turn out better. And that means you need to pick a lane on various issues.”
Warsh is due to speak at the event on Friday, with the markets closely watching what he says, or what he doesn’t.
“If he uses the speech to focus solely on broader structural themes such as productivity or demographics, we worry markets could interpret the message as dovish,” BoFA analysis said.
Speaking of the impact of a dovish speech, Benjamin D. Jones, global head of research at Invesco, told CNBC, though it helps the front end of the curve, it risks pushing the long end and inflation expectations higher. Meanwhile, “A hawkish speech might restore some credibility and help the long-end of the Treasury curve, but it would tighten conditions for parts of the consumer sector that are already struggling with high gasoline prices.”