Author: Bu Shuqing, Wall Street Insights
According to a report by the UK's Financial Times on Thursday, if inflation data remains hot in the coming weeks and market expectations for a rate hike intensify, Federal Reserve Chairman Warsh is prepared to raise interest rates at the September policy meeting.
The news pushed U.S. short-term Treasury yields higher. Despite a massive sell-off in Treasuries following last week's policy meeting, Warsh insists on pursuing his streamlined communication strategy.
The report states that people familiar with Warsh's thinking said he acknowledges missteps in communication since taking office as Fed chair, including failing to sufficiently reinforce the core message on price stability and creating market confusion over whether long-term reform plans affect near-term monetary policy. However, these sources insist these mistakes are not enough to make him abandon the overall reform direction.
After the Fed's meeting last week, U.S. long-term Treasury yields surged sharply, with the 30-year yield hitting its highest level since 2007. Investors widely believe that Warsh's limited information disclosure has undermined his credibility in fighting inflation, while inflationary pressures triggered by Trump's Iran war have further increased uncertainty about the interest rate outlook.
Adhering to Streamlined Communication, Not Yielding to Market Pressure
Since taking over as Fed chair in May this year, Warsh's most significant policy shift has been to drastically reduce forward guidance to the market. His predecessors Powell, Yellen, and Bernanke were all committed to providing detailed economic outlooks and policy signals, while Warsh is taking the opposite approach.
After leaving the Fed in 2011, Warsh had repeatedly publicly criticized "forward guidance," believing this practice trapped successive chairs by their own words and led to excessive policy commitments.
He believes that a more streamlined communication strategy will allow officials to more clearly read the market's true assessment of economic health, thereby reducing policy errors.
Warsh has publicly stated that the real "trigger-pullers" making investment decisions in the bond market understand his approach, and that criticism mainly comes from "people without investment responsibility who can only succeed when everything is carefully scripted."
Eric Wallerstein, chief macro strategist at Clocktower Group and advisor to former Fed governor Stephen Miran, said, "I don't understand where the market's negativity towards Warsh comes from."
Probability of September Rate Hike Rises to 55%, Interest Rates Remain Primary Tool
According to CME Group data, futures markets currently price in a roughly 55% probability of a 25-basis-point rate hike at the September meeting.
Informed sources said that although Warsh has raised the possibility of shrinking the Fed's $6.7 trillion balance sheet to tighten monetary policy, interest rates remain the primary tool for now and will be used at future meetings if necessary.
The Fed's preferred inflation gauge recorded 3.7% in June, having deviated from the 2% target for over five consecutive years. The market benchmark inflation expectation indicator—inflation swap data—shows investors expect an average annual inflation of about 2.4% over the next five years (starting five years from now), which has declined slightly recently. Informed sources believe this indicates the market still trusts the Fed's commitment to achieving price stability.
Torsten Sløk, chief economist at Apollo Global Management, said, Warsh was treated unfairly last week. "There is a growing consensus in the market that forward guidance is not a good idea; it leaves too little flexibility for central banks." However, he also noted that Warsh could do more to explain his plans for reducing inflation.
Jackson Hole Speech Could Be Key Moment
Informed sources said any major reforms to the monetary policy-making process will be delayed until at least next year, when the working groups Warsh announced at his first press conference in June will submit reports to the Federal Open Market Committee.
Warsh is expected to deliver his first speech at the Jackson Hole symposium hosted by the Kansas City Fed later this month. This important occasion, closely watched by markets, is seen as an opportunity for him to explain the theoretical framework behind his "silent revolution," including clarifying what he believes were shortcomings in his own messaging.
Eric Wallerstein expects, "This speech will set a tone of him wanting to leave his mark. The central banking profession has had a difficult period with many mistakes, including by the Fed itself. Warsh wants to face that and try to steer a better course."
