No forward guidance and moving inflation goalposts destabilized bonds, argues economists
JPMorgan's U.S. economic team think Warsh's performance after the FOMC last week was the most troubling in fifteen years
JPMorgan's U.S. economics team says last week's post-decision press conference by Fed Chair Kevin Warsh was the most troubling since the practice began in 2012 as the U.S. banking giant moved forward their call for a rate increase.
The team of Michael Feroli, Michael Hanson and Abiel Reinhart said the upshot of the perceived damage to Fed's inflation-fighting credentials has increased the potential urgency of the need to stiffen monetary policy, so the JPMorgan team have brought forward the timing of the next rate hike expected from the second half of 2027 to as soon as December this year.
Feroli and his colleagues articulated their concerns in JPMorgan's weekly prospects note, dispatched to clients late Friday. What troubled Feroli was that "tough talk on inflation" from Warsh was undermined somewhat by the failure to provide forward guidance, the lack of explanation as to why the Fed had kept rates unchanged and the doubts Warsh expressed about the continued use of personal consumption expenditure price index as the Fed's chief measure of inflation.
Warsh's comments appeared to cast doubt on the continued use of PCE as the Fed's principal means of measuring inflation.
Warsh first said PCE remained the Fed's focus before then adding, "Who knows come after next January, what we might say about strategy. I suspect the task forces might have something to add."
If Warsh does not know then it seems fair to argue that the markets don't either, say the JPMorgan economists. What alarms bond markets is the possibility that these task forces may not be sufficiently independent and just rubber-stamp Warsh's monetary policy bias and also that Warsh may be looking for a means of moving the goalposts on inflation by changing the Fed's benchmark.
It was the bond market that made its feelings clear: "The market didn't like what it heard, with the curve sharply steepening and breakeven inflation compensation rising as the chair spoke."
Feroli now thinks the rest of the Federal Open Market Committee will feel it incumbent upon them to defend its price stability mandate and so he expects a 25 basis point hike in December, while acknowledging "there's clearly a risk that the FOMC hikes at the next meeting in September."
July's consumer price index report, due on Aug. 12, now assumes crucial significance in the debate over what, if any, policy measures may be necessary at the FOMC September 15-16.
Economists at Bank of America were also alarmed, in a separate note to clients.
"Steeper curve, lower equities, and a weaker dollar is the closest to the price action associated with typical credibility shocks faced by [emerging market] central banks," they wrote. "The Fed is facing a growing credibility problem. Absent a run of dovish data, hiking in September will become imperative for the Fed to regain the narrative."
New York Fed President John Williams, in an interview with Reuters published on Monday, said he still thought monetary policy was in a good place but said the central bank may need to act depending what core inflation readings say.
The yield on the 2-year Treasury BX:TMUBMUSD02Ywas 4.25%, down slightly from before the Fed decision, while the 30-year yield BX:TMUBMUSD30Y was 5.22%, up over 10 basis points from before Warsh started talking.
S&P 500 futures (ES00) were higher on Monday as oil prices fell.
-Jules Rimmer
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