CITIC Securities has released a research report stating that Fed Chair Warsh's recent Jackson Hole speech strongly defended the central bank's commitment to fighting inflation, a tone that was more hawkish than his remarks at the July FOMC meeting. While market expectations for a September rate hike have risen considerably, the firm maintains its baseline view that the Federal Reserve will hold rates steady at the September meeting, based on its forecasts for U.S. inflation and economic growth. The incoming inflation and employment data will be crucial.
In the near term, a revival in market pricing for rate hikes is boosting the U.S. dollar, which is bearish for gold. However, over the medium term, a decline in long-end real interest rates should still support the upside potential for gold prices, albeit at a slower pace.
CITIC Securities' primary takeaways are as follows: Fed Chair Warsh delivered his speech at the Jackson Hole symposium on August 28. The firm suggests his comments were more hawkish than those following the July FOMC meeting, but he also provided some clarifications on core principles of monetary policy implementation. The situation hasn't worsened. This was a pre-prepared speech, likely reviewed multiple times. Its potential market impact was probably carefully considered by U.S. officials.
Compared to releasing dovish signals, accepting a "temporary rise in short-term rates" in exchange for "medium-term stability in long-term rates" appears to be a more controllable choice for U.S. officials to reduce interest rate market volatility at this juncture. Given Warsh's speech and the Treasury's recent expansion of its buyback program, which both appear to limit the long-end term premium, the firm sees no near-term catalyst that could significantly push up the term premium on U.S. Treasuries.
The more hawkish stance was evident in two areas. First, Warsh noted that while PCE and CPI readings this summer were better than expected, they haven't convinced him that the underlying trend has "meaningfully improved." He stated inflation remains above the Fed's 2% target, and the central bank needs to be certain that underlying inflation is moving toward its goal "clearly and at sufficient speed," otherwise "there is a lot more work to do." Second, he argued it is "difficult to describe the overall financial conditions as restrictive." This contrasts with his comments at the June press conference, where he deflected a question on whether financial conditions were tight to various working groups.
His clarifications on monetary policy implementation principles can be summarized in three points. First, addressing market doubts about the Fed's inflation goal, he stated: "There should be no misunderstanding: the Federal Reserve's price stability goal of 2% as measured by the Personal Consumption Expenditures (PCE) price index is a steadfast, fixed target." Second, regarding the choice of inflation metrics, he focused on the portion of PCE components exceeding 3%, which appears to be a more objective inflation gauge than his previous attempts with the trimmed mean PCE. Third, after previously being vague about which tools the Fed should rely on, he stated that "the short-term interest rate is the primary tool for achieving the dual mandate," clarifying that "higher inflation will require a higher federal funds rate to address it," thereby emphasizing the primacy of the federal funds rate over the balance sheet.
These clarifications on targets and principles could help reduce the term premium and potential market volatility. Furthermore, he spent a significant portion of his speech discussing the economy, which sounded more professional than his previous remarks. He offered little new insight in response to questions about abandoning forward guidance and did not commit to a clear "reaction function."
Maintaining the baseline call for no change at the September meeting, future inflation and employment data are paramount. Warsh's Jackson Hole speech robustly defended the Fed's duty and determination to fight inflation, reaffirmed the dual mandate, and was more hawkish than his comments from the July FOMC. Although market expectations for a September hike have increased, CITIC Securities sticks to its baseline forecast that the Fed will hold rates steady in September, based on its projections for U.S. inflation and growth trends. The near-term repricing of hike expectations strengthens the dollar and weighs on gold, while the medium-term downtrend in real long-term rates continues to back gold's upside potential, albeit with a slower slope.
Risk factors: If U.S.-Iran conflict unexpectedly escalates, or long-term rates rise again due to inflation risk premiums, the risk of the Fed being forced to raise rates preemptively to stabilize financial markets increases, especially given the "cost of living affordability" as a central inflation issue in the midterm elections. However, any hike this year would likely be a symbolic, one-off move. Also, a surprise surge in the labor market could alter the trajectory.
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