Kevin Warsh Faces First Jackson Hole Test With Markets Split On September Hike

What Happened

The Jackson Hole symposium, held from August 27 to 29, has the official theme “Financial Innovation: Implications for Payments and Policy.” However, investors are likely to pay much closer attention to what Warsh says, or does not say, about inflation, interest rates, and the recent heightened volatility in the US bond market.

This strategy, however, comes at a cost: Investors struggle to understand precisely how the new Fed’s reaction function works. Jackson Hole could therefore become less about the next rate hike and more about Warsh’s credibility.

The paradox is that Warsh’s attempt to make markets less dependent on the Fed could, at least in the short term, make monetary policy more difficult to understand. Forward guidance traditionally allows investors to anticipate central-bank decisions, thereby reducing the risk of abrupt changes in expectations.

The problem for Warsh is that simply reaffirming the 2% target may no longer be enough. Standard Chartered believes the Fed Chair needs, among other things, to restore confidence in the central bank’s determination to lower inflation and convince investors that a less interventionist Fed does not threaten macroeconomic stability.

Market Context

Since taking over at the Fed in May, Warsh has sought to reduce markets’ dependence on forward guidance. His objective is to allow economic data and markets to play a greater role in shaping interest-rate expectations rather than speeches from policymakers.

Jackson Hole does not always produce a change in monetary policy. However, several Fed chairs have used the symposium to deliver messages that profoundly influenced financial markets.

Ben Bernanke opened the door to further quantitative easing measures in 2010 and 2012. Jerome Powell used his 2022 speech to firmly reaffirm the priority of fighting inflation, before preparing markets for the beginning of the monetary easing cycle two years later.

The stakes are high as markets remain divided over the Fed’s next decision. Futures currently imply a chance of around 38% that the central bank will raise interest rates in September, according to the FedWatch tool.

Warsh’s Communication Strategy Is Becoming a Market Risk

Warsh instead believes that an overly communicative Fed can prevent markets from fully playing their role. That break with the past is now at the heart of the debate. DBS Bank strategist Philip Wee sees Jackson Hole as an important test for the new chair:

“The market needs a coherent policy framework.” He adds: “Without one, reduced forward guidance risks becoming less a return to market price discovery and more a source of uncertainty.”

Warsh does not need to tell markets what the Fed will do in September. But he may need to explain more clearly what would cause the central bank to act.

Can Warsh Reassure Markets Without Promising a Rate Hike?

The main test will probably concern inflation. The Fed maintains a 2% inflation target, but price pressures remain elevated enough to sustain the debate over another rate hike.

An explicit message about the possibility of raising rates could help restore credibility. Warsh will probably need to make clear that the Federal Open Market Committee (FOMC) is prepared to raise interest rates if inflation fails to slow sufficiently.

However, MUFG argues that the inflation outlook does not justify the increasingly hawkish rhetoric coming from some FOMC members. While core Personal Consumption Expenditures (PCE) inflation accelerated during the first half of the year, price pressures are expected to ease over the coming quarters as supply shocks fade.

The US Bond Market Makes Warsh’s Task More Complicated

Why It Matters

Kevin Warsh is preparing to deliver his first Jackson Hole speech as Federal Reserve (Fed) Chair on Friday, and expectations extend well beyond whether interest rates will be raised or left unchanged in September.

Kevin Warsh arrives in Wyoming with a different philosophy. At his July press conference, he said he had not yet decided whether his speech would focus on broader structural questions or take a more traditional approach centered on monetary policy decisions expected between September and December.

Deutsche Bank believes the first option could see Warsh discuss the five task forces created by the Fed or the economic implications of Artificial Intelligence (AI). Under a more traditional format, he could instead revisit some of the ambiguities left by his July press conference and clarify his assessment of inflation and financial conditions.

Several policymakers are also concerned that inflation remaining above target for too long could eventually undermine inflation expectations among households and businesses.

MUFG notes that inflation forecasts in the Philadelphia Fed’s Survey of Professional Forecasters have changed very little in recent months.

The bank also highlights that alternative inflation measures favored by Warsh, including Trimmed-Mean and Median PCE, show inflation running much closer to the Fed’s 2% target, suggesting that the current Federal Funds Rate (FFR) remains restrictive.

Details

Why Warsh’s Jackson Hole Speech Matters So Much