Stephen Miller
The financial market commentariat would have us believe that Federal Reserve Chair Warsh’s Congressional testimony was “hawkish”.
Fair enough! Despite a benign June consumer price index (CPI) report and last night’s benign producer price index (PPI) report, Warsh noted that it didn’t follow that it was ‘mission accomplished’ on inflation. He added for good measure that the Fed’s interest rate setting committee had ‘no tolerance for persistently elevated inflation’ and further, were united in ‘a resolute commitment to restoring price stability’.
I would note that it would be highly problematic for a central bank chair to communicate anything other than a ‘resolute commitment’ to fighting (what appears to be elevated and “sticky”) inflation.
Warsh gave nothing away regarding the likely Fed stance that will emerge from the next meeting of the Fed’s interest rate setting committee on July 28-29. (For what it is worth, markets dialled down their expectations of a tightening at the July meeting to a trivial level in the wake of the benign inflation reports but are still pricing slightly more than one further tightening before year-end).
All in all, Warsh’s comments are consistent with the notion that statements from this Fed Chair may well assume a more Delphic quality than that to which financial markets have become accustomed.
Warsh has indicated a strong antipathy for central bank “forward guidance” and by implication, the utility of the Fed’s “dot plot”. He did not submit a “plot” at the most recent Fed policy meeting and has made it clear that he doesn’t put too much store in the accuracy of the “plot”.
In essence, Warsh appears to doubt that the “dot plot” is additive to the information set of the Fed or markets. Indeed, he implies that in some instances the exercise is possessed of a certain disutility, insofar as such projections are innately ephemeral and create a damaging facade of an anchoring mechanism that bears no relation to unfolding reality.
In this sense it might be that to the extent that markets have inferred a tactical “hawkish” tilt under Warsh, it might be misplaced.
What Warsh has articulated is a desire to reframe the Fed’s strategic direction via the establishment of a series of taskforces covering communication, Fed balance sheet management, a review of data sources, productivity and jobs, and inflation drivers and measurement.
Having said that, to the extent that one could draw any conclusions regarding the benign June inflation reports it is that they appear to be some way from necessitating an increase in the Fed policy rate.
Inflation, however measured, is still north of the Fed’s 2 per cent target but looks to be trending (very grudgingly) downward despite tariff impacts and the surge in oil prices in the wake of the Iranian conflict. Of course, it might be argued that with respect to oil prices, the jury is still out when it comes to potential contagion effects on broader inflation and inflation expectations, particularly in the wake of the reescalation of the Iranian conflict.
The taskforces on productivity and jobs and price and inflation frameworks play into a theme that Warsh has in the past been quite vocal about. Specifically, Warsh conjectures that disinflation in the US will follow from tremendous (largely AI motivated) investment. In Warsh’s view that investment has wrought a productivity dividend that (other things equal) has raised the US economy’s “speed limit”. In other words, the US economy can grow at faster rate before igniting inflationary pressures.
The notion that AI driven productivity growth can constrain inflation is a credible – if debateable – position. Some worry that the huge capex requirements associated with AI might in the short-term put demand pressure on inflation.
What is also interesting is that when it comes to inflation measures, Warsh has indicated that he prefers the Dallas Fed trimmed-mean measure of the PCE. That measure was 2.4 per cent in in May, a full percentage point below the traditionally preferred core PCE at 3.4 per cent and occurs despite those aforementioned broad-based price pressures emanating from the Trump tariff agenda and oil price increases. Like other measures, the Dallas Fed inflation measure is still north of the Fed’s 2 per cent target for “inflation” but further away from mandating a policy rate increase than the traditionally preferred measure.
If that remains the case (an admittedly big “if”) and if Chairman Warsh can convince other FOMC members of the veracity of his viewpoint (a similarly big “if”) then a policy rate hike might be a more remote prospect than markets currently contemplate.
Further, Warsh’s more strategic focus might mean less frequent policy adjustments than have been seen in the past.
Instead, an extended period of a stable policy rate might be a more credible scenario.
By Stephen Miller, investment strategist
