Kevin Warsh said what he had to say on Friday to protect his credibility and that of the US Federal Reserve Board. The bigger question is whether he will do what he has to do when the Fed meets in a couple of weeks.
Warsh’s speech at the annual Jackson Hole conference of economists and central bankers in Wyoming needed to restore some confidence in the Fed after his less than reassuring performance after the Fed’s July meeting, which left markets unsure of his commitment to combatting America’s elevated inflation rate.
At that meeting, in his first press conference as Fed chair, not only did he not provide the forward guidance that he has an aversion to, but he left the impression that the Fed was comfortable with the current monetary settings – where US inflation is running at 3.7 per cent, and would move only if new data forced it to.
On Friday, he sought to dispel that impression and other preconceptions drawn from his prolific commentaries on monetary policy, burnishing his credentials as an inflation hawk, albeit that he didn’t actually commit himself or the Fed to any course of action.
“There should be no misunderstanding,” he said.
“The Fed’s price-stability objective of 2 per cent, as measured by the personal consumption expenditures (PCE) price index, is a firm, fixed target.
“Price stability is not self-executing, nor is inflation necessarily mean-reverting. It’s the Fed’s job to deliver stable prices.”
The Fed has a dual mandate: maximising employment while maintaining stable prices. Warsh was positive about employment, and said the labour markets were consistent will full employment, but he was concerned about price stability.
“The Fed’s preferred measure of inflation, the 12-month change in the PCE price index, stands at 3.7 per cent, while the six-month change is 4.1 per cent. The comparable measures from the consumer price index (CPI) are also elevated, as are the core measures of both PCE and CPI inflation,” Warsh said.
“None of these measures are perfect, but they all tell a similar story: inflation is running above our 2 per cent target. So the Fed’s predominant focus now should be on prices.”
The responsibility for 65 months of sustained elevated inflation, he said, sat squarely with the central bank.
“Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job … our mandate … and our charge to keep.”
After his speech, the markets-derived odds on a Fed rate rise after its September 15-16 meeting jumped from less than 50 per cent to more than 60 per cent.
The speech dispelled a number of reservations about Warsh’s commitment to fighting inflation.
He has talked about an artificial intelligence-driven boost to productivity that would lower inflation. Now he says the Fed will be thinking about the impacts of AI, but that the central bank will have no bearing on the government’s current policy decisions.
He has also talked about reconsidering the key measures the Fed uses to evaluate inflation, raising fears that he was going to shift – and lower – the target for assessing it.
Some of the measures he has canvassed, like trimmed mean inflation, exclude some impacts of the very factors, like AI, Donald Trump’s tariffs and the war in Iran, that have driven the inflation rate up.
Now, he has recommitted the Fed to the PCE as its preferred measure.
Warsh hasn’t walked away from his aversion to providing the markets with guidance, saying the Fed’s practice of providing indications of its thinking, a practice adopted during the global financial crisis, was one of the “legacies of crises past”. It had, he believed, “outstayed its welcome”.
“In normal times, the role of forward guidance should be limited and circumscribed. Otherwise, it risks ambiguity in the name of clarity. Oversharing policy deliberations and overcommitting to future decisions can lead markets, businesses and households astray,” Warsh said.
The Fed, he said, needed clear market signals – the level and change in assets prices, the price and trading volume of Treasury securities, the foreign exchange value of the dollar, the cost and availability of credit and the prices of a broad set of commodities to inform it of the near-term outlook for economic activity and inflation.
Market participants should track real information across the economy and draw their own conclusions from their own expectations of output, employment and inflation.
That’s a legitimate point of view – providing forward guidance can provide false comfort to the markets and also warp the Fed’s own decision-making – but one that is being challenged by the actions of US Treasury Secretary Scott Bessent, who will soon be trying to distort the signals Warsh is placing so much reliance on.
Bessent announced recently the Treasury would start buying $US4 billion of US longer duration bonds, perhaps more, ostensibly to supply more liquidity to a section of the bond market he says doesn’t reflect the underlying fundamentals of the US economy.
What he’s actually trying to do is to drive down yields and the interest cost to the US government that have spiked because of those fundamentals – the Trump administration’s rapidly expanding deficits and debt.
The deficit is nearing $US2 trillion – about 5.9 per cent of US GDP – while US government debt has just passed $US40 trillion, having been $US36.1 trillion when Trump regained the presidency last year. Rising interest costs – currently running at an annualised rate of more than $US1.2 trillion – are threatening to swamp other government expenditures.
‘Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job … our mandate … and our charge to keep.’
Fed chair Kevin Warsh
Trump’s war in the Middle East and its impact on energy prices and inflation has been another factor.
Just ahead of the conflict, the yield on two-year Treasury notes was 3.38 per cent, with the 10-year bond yield 3.94 per cent and the 30-year yield 4.61 per cent. Today, those yields are 4.35 per cent, 4.72 per cent and 5.21 per cent, respectively.
If Bessent was to suppress the yields on the longer dated bonds – which are the reference points for the interest rates that really matter for the government, businesses and households – it would confuse the pricing signals being sent to the Fed.
Mind you, the attempt is likely to be futile. Buying a few billion dollars of bonds at a time, or even a few hundred billions of bonds, is unlikely to have any material or lasting impact on a market where $US31.5 trillion of securities are traded.
Where his announcement of the program, scheduled to start on September 9, may have an impact – another one unhelpful to the Fed – is on the value of the US dollar.
A sustained attempt to cap US yields would raise fears of a “dollar debasement” trade, or the US deliberately targeting dollar depreciation, which would devalue foreign investors’ bond holdings in the process. Currency depreciations are inflationary.
The only way for Bessent to produce sustainably lower bond yields is to fix the fundamentals of the American economy, which would mean massive reductions in the US deficit via massive spending cuts, which is most unlikely to happen.
Similarly, if Warsh wants to tighten monetary conditions that he now appears to have conceded are too loose and generating an inflation rate that it too high, he has no option other than to deploy the Fed’s “predominant tool” – short-term interest rates – to tighten conditions and bring the inflation rate down.
That wouldn’t, of course, endear him to the president who appointed him with an expectation that he would do what Trump keeps demanding and lower interest rates. A Fed rate rise in the run-up to the US midterm elections would risk Trump’s ire, but be a powerful signal of the Fed, and Warsh’s, independence.
The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.
From our partners
About the Author
