The Big Picture

Briefing.com Summary:

*Fed Chair Warsh has reduced forward guidance, leaving markets to infer the Fed’s policy path from economic data.

*Persistent above-target inflation strengthens the case for a September rate hike, particularly if market expectations shift decisively toward one.

*Holding rates steady could test Warsh's credibility given his criticism of the Fed’s prolonged tolerance of above-target inflation.

It has been said that the market has a tendency to "test" a new Fed chair. However, the newest Fed chair, Kevin Warsh, seems to be testing the market.

He is loathe to provide forward guidance and hasn't. He has been quick to organize task forces, with designs on utilizing new inputs that will help the Fed make its policy decisions. He has laid "the responsibility for 65 months of sustained, elevated inflation" at the Fed's doorstep.

In general, though, he has basically told the market to think for itself in assessing the policy outlook. We will soon find out if that approach comes back to bite him—or to test him, if you will.

Not a Static Indication

The next Federal Open Market Committee (FOMC) meeting is September 15-16. At that meeting, the Fed is expected to... well, the market hasn't made up its mind about what the Fed will do.

Its expectations have been blowing in the wind of remarks from Fed officials (old habits die hard), the vapor trail left by economic releases, and the ebb and flow of oil prices.

The latest indication provided by the CME FedWatch Tool is that there is a 58.4% probability of a 25-basis-point rate hike to 3.75-4.00% at the September FOMC meeting. That is up from 49.4% just a day ago, catalyzed by a stronger-than-expected nonfarm payrolls print in the August Employment Situation report.

Clearly, this isn't a static indication, but in terms of the market's prevailing policy view, it should be solidified in the wake of the August Consumer Price Index (CPI), which is slated for release on September 11. The fed funds futures market will think for itself after that report, offering an information signal for the FOMC that it can choose to embrace or ignore at its own peril.

If the CPI report pushes the probability of a September hike decisively above 60%, the burden will shift to the Fed to explain why it is comfortable standing pat despite persistent inflation and a market increasingly expecting tighter policy.

Holding back on a rate hike would risk frustrating a market that has been told to think for itself and would put Mr. Warsh's credibility on the line given his repeated acknowledgment since becoming Fed chair that inflation has been running north of the 2.0% target for more than five years.

Three's a Crowd

From our vantage point, that is a tacit criticism of Jerome Powell's leadership—the same Jerome Powell who remains a Fed governor and occupies a seat (and vote) at the committee table now headed by Kevin Warsh.

It is important to remind readers that the Fed chair is still only one vote on the FOMC, so he/she doesn't decide the monetary policy. It is a majority decision by the committee, but it is the Fed chair's job to steer a consensus decision.

There were three dissents at the last FOMC meeting. Cleveland Fed President Hammack, Minneapolis Fed President Neel Kashkari, and Dallas Fed President Lorie Logan all preferred to raise rates by 25 basis points. With oil prices higher than they were at the time of the last FOMC meeting, the prices paid index for the ISM Services PMI at its highest level since August 2022, and PCE inflation still well above the 2.0% target, there is little reason to think they wouldn't still be in favor of raising rates.

The bigger question is, will at least four other committee members come around to thinking the same? That would form a majority for the 12-person committee. Fed Governor Waller said he could be inclined to vote for a rate hike if progress toward the 2.0% target isn't seen in the August inflation data.

Many reports suggest that the ultimate decision is riding on the August Consumer Price Index and whether it conveys a trend of disinflation that would be just enough to convince the majority of FOMC voters to leave the target range for the fed funds rate unchanged at 3.50-3.75%.

That target range has remained untouched since December 2025. In the intervening period, AI capex spending has exploded, oil prices have surged 58%, memory prices have soared, and copper prices have risen 25%. It is misleading to say that everything has gone up in price since then, but it is fair to say that many goods and services cost more today than they did then.

Mr. Warsh spoke to some of the persistent inflation pressures in his speech at Jackson Hole, observing that 54% of goods and services in the PCE basket showed price increases above 3.0% over the last 12 months, well above the 32% in the two decades that preceded the pandemic, while 49% showed annualized price increases above 3.0% over just the past six months.

Briefing.com Analyst Insight

Those are some inconvenient truths for a Fed that is sticking with the same policy rate. Mr. Warsh, however, rightfully pointed out that measures of inflation expectations, in the medium term, look stable before astutely observing that, in economic history, measures of inflation expectations tend to look strong and durable until they don't.

The 5-year breakeven inflation rate, which is a measure of what the market expects inflation to be in the next five years, on average, stands at 2.37%. That is some consolation for the Fed, as it suggests the market continues to expect inflation to moderate substantially in the medium term.

For the record, the five-year breakeven inflation rate stood at 2.51% five years ago. CPI has averaged 4.40% over the past five years, so the market's inflation expectations five years ago were off the mark.

Today is the "medium term" from 65 months ago, and PCE inflation isn't just above 2.0%; it is above 3.0%. The same can be said for the core-PCE price index, which excludes food and energy. The CPI inflation rate is 3.3%, and core CPI is 2.5%.

What matters most now to consumers everywhere, though, is the near-term inflation rate.

Frankly, why should one additional month of CPI improvement outweigh the accumulated evidence of persistent above-target PCE inflation? Mr. Warsh himself said at Jackson Hole that the Fed should not rely on isolated data points because "trends matter most." The inflation record is unmistakable: it has remained above the Fed's 2.0% target for more than five years, and the policy rate hasn't been increased in three years.

We understand why the CPI report matters greatly from a trading standpoint, but from a policy standpoint, and Mr. Warsh's own seeming dismay at how long PCE inflation has remained above the "fixed, firm" 2.0% target, a rate hike in September appears to be in order.

The new Fed chair has deliberately reduced forward guidance and told markets to infer policy from the data. If inflation remains stubborn (as it has) and markets consequently price a hike as a clear favorite, doing nothing would require a convincing explanation—particularly from a chair who has repeatedly criticized the Fed for tolerating above-target inflation.

Mr. Warsh has set a high rhetorical bar for tolerating inflation. If the incoming data don't materially improve and markets conclude that a hike is warranted, a decision to hold will force Mr. Warsh to reconcile the FOMC's actions with his own diagnosis of the inflation problem.

The market may just turn a deaf ear in that case, though, concluding that the new Fed chair's inflation bark is worse than his inflation-fighting bite.

--Patrick J. O'Hare, Briefing.com