Warsh's latest remarks have left Wall Street in a state of confusion. The day after the Federal Reserve's latest rate decision, a key inflation metric closely tracked by monetary policymakers eased in June, though it remains well above the central bank's 2% target. With the economy's underlying drivers still broadly solid, the policy response from the Fed under new Chair Kevin Warsh has sparked increased market speculation, leaving the central bank's policy path increasingly unclear.
Persistent inflation pressures remain. Data released Thursday by the Commerce Department showed that the Personal Consumption Expenditures (PCE) price index fell 0.1% month-over-month in June, dragged down by lower energy prices. The annual PCE inflation rate eased to 3.7%, down from 4.1% in May, after hitting a three-year high. Excluding volatile food and energy items, the core PCE rose 0.1% month-over-month in June, with an annual rate of 3.3%, a slight cooling from 3.4% in May. Markets had expected a 0.2% monthly increase and a 3.3% annual gain. By sector, energy goods and services prices plummeted 5.9% month-over-month in June, thanks to a temporary easing of the Middle East conflict, with gasoline prices falling 9.2%. Housing inflation also cooled, rising just 0.2%. Meanwhile, overall goods prices fell 0.6%, while services prices edged up only 0.1%.
The Fed views the PCE index, particularly the core PCE, as the most reliable gauge of U.S. inflation trends. The data shows that inflation has remained significantly above the central bank's 2% policy target for the sixth consecutive year. At the same time, consumer spending showed resilience in June, with personal consumption expenditures rising 0.3% month-over-month, in line with expectations. However, personal income grew 0.2% month-over-month, below the 0.3% market forecast. As a result, households have had to rely on savings to maintain spending, with the personal saving rate falling to 2.7%, a four-year low.
The policy outlook has become increasingly murky. Given the stabilization of labor market indicators this year, inflation has become the primary focus for Fed policymakers. However, significant uncertainty remains over whether the cooling trend in inflation can continue. The key driver of the June inflation slowdown was the drop in oil prices following a fragile ceasefire and the start of peace talks between the U.S. and Iran. But deep divisions persist, and crude oil prices remain relatively high. A compilation by Yicai reporters shows that Wall Street expects inflation to likely stay above 3% through the end of the year, putting pressure on the Fed to tighten policy.
The Fed decided to hold interest rates steady on Wednesday. In a press conference, Fed Chair Warsh stated that while the Fed is determined to curb inflation, the rise in market interest rates over the past few weeks has provided the central bank with some policy buffer. However, three members of the 12-member policy committee dissented, advocating for a rate hike. Combined with the sharp rise in long-term Treasury yields on Wednesday, these signs indicate that the pressure on the Fed to raise rates is intensifying. However, Warsh's reluctance to fully elaborate on his views disappointed the market. Questions are emerging about whether he can deliver concrete policy actions to back up his tough stance on inflation. Stocks fell sharply on the day, and bonds were also sold off. Robert Tipp, chief investment strategist and head of global bonds at PGIM, commented, "Market reception has been poor." It may be too early to say that the credibility of Warsh and the Fed has been damaged, but the sharp reactions across major asset classes on Wall Street are a troubling sign.
Of course, some of the disappointment simply stems from the market's need to adapt to Warsh's distinctly different communication style—compared to his three predecessors, Bernanke, Yellen, and Powell. Warsh does not subscribe to the concept of forward guidance, which involves signaling the direction and rationale for interest rate policy to the market. After 15 years of a highly transparent communication mechanism by the Fed, there is now a noticeable vacuum in policy information. JPMorgan also adjusted its forecast this week, predicting that the Fed will raise rates by 25 basis points in December, a significant pull-forward from its previous expectation of a rate hike in the second half of 2027. JPMorgan forecasts that after the December rate hike, the Fed funds rate range will be raised to 3.75%-4.00% and then held steady. The bank also noted that a September rate hike remains a possibility if inflation continues to heat up. Data from the CME FedWatch Tool shows that the market currently prices in a 65.2% probability of a rate hike in September, down from 81% just before the policy statement was released. In fact, major investment banks are sharply divided in their views. Goldman Sachs and Barclays continue to predict the Fed will hold rates steady for the rest of the year. Bank of America Global Research expects the Fed to begin a cycle of three rate hikes starting in September. In contrast, the persistently dovish Citigroup maintained its forecast after the July FOMC meeting, predicting the Fed will cut rates in October and December of this year, followed by another cut in January 2027.
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