Federal Reserve Chairman Kevin Warsh addressed Wall Street's anxiety during his keynote speech at Jackson Hole, his first as chairman. Investors were keen for clarity after a month of silence and his prior resistance to familiar forward guidance. Warsh offered a "trail map" for his approach, emphasizing discipline over pre-emptive decisions, which some experts like Ashok Bhatia of Neuberger interpreted as an "olive branch." This came after $30$-year Treasury yields hit their highest level since 2007, with a significant portion of this year's rise in $10$-year yields stemming from real yields rather than inflation expectations.
Warsh discussed artificial intelligence, forward guidance, his guiding principles, and his economic assessment. While acknowledging AI's potential growth effects, he flagged uncertainty regarding its impact on jobs and wealth distribution. On inflation, Warsh stated that "unless underlying inflation is moving to our objective, clearly and at sufficient speed… we have work to do." He pointed out that personal consumption expenditures (PCE) inflation was running at $3.7$% over $12$ months and $4.1$% over $6$ months, with about $54$% of inflation components rising more than $3$% over the past year. He judged current financial conditions as "not restrictive," despite recent "better than expected" inflation readings.
Rich Clarida, PIMCO's economic advisor, and former Vice Chair of the Federal Reserve Board, interpreted Warsh's remarks as a clear signal for a potential rate hike in September. This sentiment was echoed by others, with swaps traders now pricing in a roughly $60$% chance of a hike next month, contingent on August's inflation data. The dollar, which had weakened in August, recovered after Warsh's speech, and the $10$-year Treasury yield ended the month at $4.75$%.
However, some investors, including Christophe Boucher at ABN AMRO and Tracy Chen at Brandywine Global, remain skeptical. They recall previous instances where Warsh's communications jolted markets, with the Fed ultimately holding rates steady. Boucher stated that "the reaction function is still unclear" and warned of potential credibility issues if a September hike doesn't materialize. Chen, while reducing her underweight position on long-dated Treasuries after the Treasury Department announced plans to double purchases of longer-dated bonds, still maintains caution, stating, "But talk is talk. Action speaks louder."
Despite Warsh's focus on inflation, the US jobs market presented a mixed picture, with July payrolls falling by $23,000$. Ben Yearsley, director at Fairview Investing, commented that "Rate rises might be the right medicine for inflation, but the patient is starting to look a little peaky." Amidst this uncertainty and Warsh's unconventional communication style, the market's initial reaction, including a decline in $30$-year yields, suggests a strengthening of Fed credibility, which could eventually benefit long-duration fixed-income assets by lowering both real yields and breakevens.
