In the wake of Federal Reserve Chair Kevin Warsh's remarks at Jackson Hole, the bar for a September rate increase has been notably lowered, according to T. Rowe Price's chief U.S. economist, Blerina Uruci.
Uruci suggests that for the Federal Open Market Committee to hold rates steady, core inflation would likely need to show a significant cooling, perhaps with month-over-month gains dropping to around 0.1%. While Warsh avoided making a definitive commitment on the future rate path and reiterated that decisions will remain data-dependent, the articulation of his policy reaction framework has shifted the overall stance to a more hawkish tilt.
The current market assessment places the probability of a September move at approximately 50%.
Looking ahead over a 12-month horizon, the medium-term rate outlook remains biased towards easing, as inflation is still expected to decelerate gradually. However, the near-term direction of policy, whether it involves cuts or hikes, may hinge more on immediate inflation progress rather than multi-month trends. Should inflation cool too slowly, Warsh may need to implement more than one rate hike to bolster the Fed's credibility in its fight against price pressures.
Warsh's address has reinforced his anti-inflation credentials. By avoiding a promise on the rate trajectory while clarifying the conditions under which policy might adjust, he has provided clearer guidance. It is now evident that he remains committed to the 2% target for the PCE price index, sees no major risks to full employment, and does not view overall financial conditions as particularly tight.
This indicates the Fed remains in an anti-inflation policy mode.
Warsh's difficulty in describing the current financial landscape as "tight" is particularly noteworthy. It implies that recent bond market selloffs and rising yields may not suffice to substitute for further monetary tightening. The pivotal factor for future rates is the inflation trend. The September FOMC outcome will be highly data-dependent, but the threshold for a hike has been reduced.
As markets now understand, unless employment data deteriorates markedly or core CPI moderates to around 0.1% month-over-month, the rationale for holding rates steady could be insufficient.
Warsh's perspective on wages also merits attention. He pointed out that wage growth has historically been an unreliable predictor of future inflation. This suggests the Fed may not pivot towards easing simply due to slowing wage inflation, but instead will focus more directly on the breadth and persistence of price pressures.
Another key signal stems from Warsh's examination of PCE subcomponents. Currently, 54% of the 199 PCE line items still show inflation running above 3%. While this ratio has declined from its post-pandemic peak, it remains significantly higher than pre-pandemic levels. Under his framework, the Fed would need to see broader disinflation before considering its anti-inflation work nearly complete.
T. Rowe Price maintains a positive outlook on U.S. economic growth. Although consumer spending has decelerated from post-pandemic highs and job growth is moderate, drawing attention to risks of weaker consumption, the economy is buoyed by a more powerful force: a robust capital expenditure cycle driven by artificial intelligence. This should continue to support both economic and market performance.
Historically, as long as the unemployment rate stays low, U.S. household spending tends to remain resilient even amidst some softer consumer segments. Fiscal policy also lends support, with the economy near full employment yet still carrying a substantial budget deficit, which continues to provide stimulus.
The U.S. labor market is in a delicate balance, characterized by low hiring and low layoffs. Labor supply is constrained by structural factors including an aging population and tighter immigration policies, while private-sector demand for workers has moderated. This may partly reflect over-hiring during the pandemic era and a past tendency to retain employees, with early AI adoption also prompting some firms to pause or reduce recruitment.
Consequently, even with the unemployment rate at historic lows, the labor market does not appear overheated. Wage data corroborates this, with wage inflation having gradually cooled over recent quarters, and momentum in average hourly earnings now at post-pandemic lows. Meanwhile, labor income as a share of overall economic value added is still declining, while corporate profit shares are rising. This implies wage costs are not significantly squeezing profit margins, limiting the pressure on businesses to raise prices due to higher labor expenses.
U.S. inflation is projected to peak around mid-2026 and then gradually recede, which has been a primary reason for T. Rowe Price's dovish medium-term policy stance. This inflation outlook rests on three pillars: normalization in housing inflation, subdued core goods inflation as the peak effects of tariffs and dollar movements fade, and services inflation excluding housing, which may be stickier but should still allow a gradual move toward the 2% target if the other components continue to cool.
The July CPI data largely supports this view, with three-month and six-month momentum decelerating across several major inflation categories. However, following Warsh's Jackson Hole speech, even if the inflation forecast remains unchanged, the Fed's patience with slow disinflation may be wearing thin. In short, the likelihood of further near-term monetary tightening has increased versus previous expectations.
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