Stephen Miller
Since the conclusion of the last Fed Federal Open Market Committee (FOMC) meeting, the US financial market commentariat have spent some time highlighting Fed Chair Warsh’s communication shortcomings.
It appears that Warsh unnecessarily let his (justified) antipathy toward forward guidance manifest itself in a reticence to communicate a rationale for the Fed’s decision to keep the policy rate steady, failing to communicate any detail regarding Fed members’ assessments of current inflation pressures, and indeed on the economy more broadly.
Warsh could have simply shared elements of the Fed’s current economic assessments without crossing the line into forward guidance.
By choosing to communicate nothing by way of a rationale for the FOMC decision the Fed Chair has created an information vacuum. In part reflecting that void, the bond market took the path of least resistance and arrived at a collective view that Warsh lacked resolve on inflation.
It probably didn’t help that President Trump opined that Warsh was doing a “fantastic job” and “would love to lower interest rates”.
That circumstance seems to have distracted the US bond market from an inflation picture that is much less challenging that might have been feared, particularly in the wake of the Trump Administration’s tariff policies and the potentially deleterious effect on inflation and inflation expectations from the surge in oil prices in the wake of the Iranian conflict.
Last night’s US consumer price index (CPI) release is another indicator of just how well US inflation has behaved despite the challenges from, among other things, tariffs and oil.
US core CPI inflation came in at 2.5 per cent, the lowest annual rate since March 2021. That was at the height of COVID deflation fears (remember that!).
Meanwhile, the traditional Fed inflation focus – the core private consumption expenditures (PCE) price index – is, at 3.3 per cent, well north of the Fed target of 2 per cent. Warsh prefers the Dallas Fed trimmed-mean measure which is currently running at 2.2 per cent (June read) – not that far from the Fed target and the lowest read since July 2021.
Of course, the vagaries of oil prices might upset that positive emergent US inflation narrative but nevertheless the forgoing results are a positive surprise.
Along with recent softer payrolls numbers they indicate that the Fed is not under any pressure to urgently raise the policy rate.
Bond markets still have a bit to worry about, particularly the huge US Budget deficit, but if Fed Chair Warsh had articulated that emergent positive narrative – and he could have done so that without crossing the forward guidance line – then perhaps bond markets might be well be a tad less anxious.
RBA: Bullock avoids the ‘Warsh trap’ but monetary policy challenges remain
Following the Fed Chair Warsh’s poorly received communication after the Fed kept rates steady in July, I conjectured that Reserve Bank of Australia (RBA) Governor Bullock would have to be on top of her communication game in the event the RBA held rates steady in the August meeting.
In the event those fears proved unfounded.
Bullock gave a credible rationale for the RBA’s decision to keep the policy rate steady. She framed the Monetary Policy Board (MPB) debate as one between keeping rates steady and increasing the policy rate, ceding the “bond vigilantes” some succour. That was given some emphasis by a stated readiness to raise the policy rate should upside risks to inflation assert themselves.
Bullock speaks from a position of greater credibility than Warsh given that the RBA had raised the policy rate at three successive meetings in February, March and May of this year. In that sense she has revealed inflation-fighting credentials in a way that Warsh has yet to demonstrate.
The June quarter trimmed-mean inflation outcome at 3.6 per cent was below the RBA forecast of 3.8 per cent issued in May. So, the argument went, the increases in the policy rate so far this year are working to contain inflation, and with activity growth tepid, the balance of risks pointed to no further requirement for an increase at the August meeting.
Bullock communicated this in a clear and balanced way, albeit one can argue whether the Board arrived at the “correct” decision.
Warsh on the other hand, unnecessarily let his antipathy toward forward guidance manifest itself in a reticence to communicate a rationale for the Fed’s decision to keep the policy rate steady, failing to communicate any detail regarding Fed members’ assessments of current inflation pressures, and indeed on the economy more broadly.
Warsh could have shared elements of the Fed’s current economic assessments without crossing the line into forward guidance.
Taking a leaf out of Bullock’s approach, Warsh might have pointed out that US inflation has been less than feared.
In other words, there were good reasons for the Fed leaving the policy rate unchanged.
Last night’s July CPI report reaffirmed that.
Warsh has in the past conjectured 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 debatable – position. Some worry that the huge capex requirements associated with AI might in the short-term put demand pressure on inflation. Indeed, it is the latter that the RBA emphasised in its articulation of upside risks to inflation.
The RBA’s decision to hold the policy rate at the August meeting, however, is not without some risk. Australia has an “underlying” inflation rate that is among the highest in the developed world. That reflects the stark reality of a homegrown structural inflation proclivity. I tend to think that the RBA underplays this factor in its public commentary.
I have noted in the past that that reflects the interplay of regulatory creep in labour and goods markets that impose costs on businesses, part of which are passed on to consumers, and which result in abject productivity growth which makes the task of inflation containment all the harder. Australia’s abject productivity growth may be why AI related capex has a greater inflation impulse in Australia.
Frustratingly, governments (state and federal; Labor and Coalition) have displayed a ‘head in the sand’ approach to dealing with these issues and unfortunately the current Federal government is no exception.
In that context, the policy rate “hold” from the RBA last week may be defensible but I continue to worry that the RBA will be required to raise the policy rate again at some stage in 2026. Unit labour cost growth in excess of 3 per cent (even if down from 5 per cent a year ago) is hard to square with a seamless return of inflation to the mid-point of the target. Too great a delay in tightening policy runs the risk of too “sticky” an inflation rate and, as a consequence, a more substantial dislocation in economic activity and in the labour market down the track.
By Stephen Miller, investment stragtegist.