INSTANT VIEW-Rate-hike expectations rise on Warsh speech at Jackson Hole

The Federal Reserve will "have work to do" if policymakers are not confident that underlying inflation is returning to its 2% target, Chair Kevin Warsh said on Friday in remarks that marked the closest he has come to acknowledging interest rate hikes may be needed to ease price pressures.

Short-term Treasuries sold off in anticipation of rate increases as soon as next month, with the 2-year Treasury yield rising 8.5 basis ​points to 4.316%, its highest in a month. The 10-year Treasury yield was up 2 basis points at 4.694% and the 30-year Treasury yield was down 0.6 basis points at 5.186%. U.S. stocks were higher late in the morning on Friday, with the Nasdaq and the S&P 500 up ​0.3%, while the U.S. dollar index rose 0.4% to 99.48, again reflecting expectations that rates will rise. The rates market was showing an even chance of a rate increase next month, up from ‌35% before the speech, according to ​CME data.

COMMENTS: CHRISTOPHER HODGE, CHIEF US ECONOMIST, NATIXIS, NEW YORK:

"The market was underpricing the odds of a Fed hike before, and I think now they're appropriately priced in. This was a marked improvement from the July press conference. Warsh" strengthened his inflation credentials by acknowledging the problem directly, reaffirming an unambiguous 2% target and accepting institutional responsibility for the Fed’s failures. With growth solid, employment stable and financial conditions loose, his diagnosis leans clearly toward holding higher rates and potentially raising them if inflation fails to improve and not using the balance sheet to achieve this.

"What Warsh explicitly says is that inflation is too high, recent progress has been modest, labor markets are consistent with full-employment and broad financial conditions do not appear restrictive. Short-term interest rates remain the predominant policy tool, and the Fed must be ready to act if inflation does not improve." MARK HACKETT, CHIEF MARKET STRATEGIST, NATIONWIDE, PHILADELPHIA:

"Warsh accomplished what he was trying to do, which is get his point of view across without really ‌disrupting the markets. Why the market is very modestly reacting is he is very adamant that the 2% inflation target is going to remain. There's been somewhat misguided thoughts among investors that this would soften a little bit. Clearly, that's not the case. He is reiterating the hawkishness, but in a more of a consistent way than an incremental way. "He's telling the market, do not expect cuts in any time until we have this thing completely under control and do prepare yourself for hikes." GARY SCHLOSSBERG, GLOBAL STRATEGIST, WELLS FARGO INVESTMENT INSTITUTE, SAN FRANCISCO:

"What Warsh said isn't surprising given the circumstances. It came after a press conference that was criticized in retrospect. He had to come out and say something about the policy outlook, reiterating the Fed's intent to control inflation, re-enforcing the Fed's inflation-fighting credentials. The market reaction was as expected. The yield on the two-year, a very policy-sensitive portion of the curve and the shorter intermediates, did move up as they anticipated a rate increase if not in September, then in all likelihood by the early part of December. "He threw a lot of dots out there and when you connect them, in effect, that's what he was saying. Unless inflation rolls over and we don't expect it to. If anything, the pressure may build a bit over the next 6 to 8 months. He didn't come right out and say it, but ‌all the ingredients seem to be there at this point for at least one rate increase, if not more going forward."

MICHAEL ROSEN, MANAGING PARTNER AND CIO, ANGELES INVESTMENTS, SANTA MONICA, CALIFORNIA: “Warsh acknowledged the reality of an economy at full employment and inflation above target, as it has been for five years. Nominal interest rates are below nominal GDP growth, which is the definition of a stimulative monetary policy, which is not an appropriate stance for an economy at full employment and inflation above target.

"The market raised the likelihood of an increase in the Fed funds rate at the September FOMC meeting and is now pricing ‌in another hike by year-end. The short-end of the curve has sold off while the long-end has rallied in response to a Fed chair that sees inflation as the primary problem. Both Warsh and the market have gotten their assessments correct.” CHRIS GUNSTER, HEAD OF FIXED INCOME, FIDELIS CAPITAL, GREENWICH, CONNECTICUT: “It’s pretty clear that the market now expects a higher probability of a Fed rate hike in September. Before the meeting, it was less than 50% probability. After the meeting, it is now over 50% probability. That is in line with the comments that he made around inflation being above target, employment being strong, and his quote about the economy being surprisingly resilient. That gives him the leeway to increase rates in the near term. “Warsh was more hawkish than expected from the marketplace. Looking at the market reaction, it says exactly that. We have lower inflation expectations on the longer term and higher inflation expectations in the really short end. That is consistent with what we’re seeing in the Treasury market with a flattening of the yield curve. Long-end Treasury rates have moved down. Front-end Treasury rates are higher. That is consistent with a Fed hiking.” CYRUS AMINI, CHIEF INVESTMENT OFFICER, HYPHEN WEALTH MANAGEMENT, MOUNT PLEASANT, SOUTH CAROLINA:

“During the speech we saw the short end of the yield curve rise while the long end moved down. This came alongside Warsh’s focus on the inflation data staying elevated, which he spoke to at length. This should quell some of the bond market anxiety as he gave a clear picture of the Fed’s stance on inflation and the need to push it down to target at sufficient speed -- his own words. “I found his ⁠communication to be very clear in ​what his Fed would and would not do. He clearly is sticking to his guns with respect to forward guidance and the risks that presents to markets. He wants the markets ⁠to assess the data and come to their own conclusions, just like the Fed is doing behind closed doors. "The one thing lacking from this speech was a credible plan to actually fight inflation. Perhaps that means he will push harder on running down the Fed’s balance sheet, but there are a lot of question marks here. He did specifically call out one of his primary methods of evaluating inflation, the disaggregation of all the specific goods/services in the PCE basket to see the inflation rates of the underlying areas. I wouldn’t be surprised to see more research on this area going forward. “Investors will likely see the Fed moving in a more hawkish direction. Warsh directly spoke to both sides of the Fed’s dual mandate, noting that labor markets were robust while inflation measures have stayed ⁠consistently well above target. The base case for their forward decisions appears to be moving slightly more toward hawkish, especially given the continued strength coming from corporate capex and equity earnings.”

EUGENE EPSTEIN, HEAD OF TRADING AND STRUCTURED PRODUCTS AT MONEYCORP IN STAMFORD, CONNECTICUT: "At least for the time being, we're getting more of the same Warsh-speak that we saw prior to any of the Fed decisions that he had been a part of. Meaning he's saying a lot, but none of this seems really substantive. The initial reaction seems hawkish, but it looks like we're just repeating or seem to be getting in the same route as we did leading up to the last Fed decision where the market was all hawked up heading into it. ​And in the end, there was nothing to be hawkish about and the dollar sold off.

"So we'll see where this goes into the next meeting next month. But I feel like I'm watching him give the same speech for the fourth time now, maybe even fifth. Because frankly, he's talking about, yes, they're going to be focused on inflation. He's not giving forward guidance, but inflation is not going in the direction that they want it to go. But he's saying all the same hawkish talking points that he said leading up to the last decision. And then the ⁠last decision he's basically like, well, the market's doing all the work for us, so we're good. "So, it's kind of like a fool me once, shame on you; fool me twice, can't get fooled again, if you know that. Yeah, that's where it seems like we're going."

OLIVER PURSCHE, SENIOR VICE PRESIDENT, WEALTHSPIRE ADVISORS, WESTPORT, CONNECTICUT: "The initial conclusion is that Chairman Warsh is giving the market what it wants to a certain extent. He's acknowledging that inflation is an ongoing issue but sticking to his guns of not being overly forward about predicting what the Fed may or may not do in the future. That's as good as you could have hoped coming out of him. The market is reflecting that."

MOLLY BROOKS, US RATES STRATEGIST, TD SECURITIES, NEW YORK: “Markets took it a bit hawkishly. We saw the market price in more ⁠hikes. The ​long end reacted in a way that the Fed might be a little bit more serious about hiking, so therefore inflation credibility may be less at risk.

“The one hawkish thing to note is that he did mention that the labor market is stable and output is strong, and then obviously they're concerned around inflation, so I think that's what led markets to view this as somewhat hawkish. “It puts the emphasis on the data that's coming up now, so if we get a stable or stronger labor market signal next week and then we get a stronger inflation print the following, then that's going to give a signal that maybe Warsh is ready to go as well.”

PETER CARDILLO, CHIEF MARKET ECONOMIST, SPARTAN CAPITAL SECURITIES, NEW YORK: “I don't think (the Fed) is going to do anything in September. (Warsh) also alluded to the fact that the summer inflation numbers were better, but not convincing. So, I think he wants to wait for one more round of inflation numbers in September, October before pulling the trigger. But the market seems think the that the Fed will likely raise rates by year end.

“He alluded to his previous statements that during his terms, they will explore new models. That might be his way of saying we might need to change the metric in which we measure inflation, which he has ⁠said that when he first took on the job. So, I that's where we're going. “He talked about AI can be a new tool for the economy. He's not scaring the markets, but of course the fact that the Fed may need to do more work on inflation is what the bond market wanted to hear.

“He's trying to cover a lot of aspects, but is the market going to be totally satisfied? I don't think so. He's basically a doing balancing act, you know. He has to satisfy the markets, and he has to satisfy President Trump as well.” SAM STOVALL, CHIEF INVESTMENT ⁠STRATEGIST, CFRA RESEARCH, NEW YORK:

"I think really what he is doing is confirming that they are going to continue to make decisions without any kind of pre-announced intentions. He's really sort of ⁠reiterating what he has said already." JAMIE COX, MANAGING PARTNER, HARRIS FINANCIAL GROUP, RICHMOND, VIRGINIA:

"Warsh said a lot without saying anything. He wants to walk the middle ground and be noncommittal, trying very hard to re-Greenspan the Fed." BRIAN JACOBSEN, CHIEF ECONOMIST, ANNEX WEALTH MANAGEMENT, MENOMONEE FALLS, WISCONSIN:

"For better or worse, Chair Warsh wants to burn the monetary policy orthodoxy house down. I think it’s for the better. He said the quiet part out loud about how money matters for monetary policy. For years, the Fed ignored the monetary aggregates. In fact, they stopped publishing some of those aggregates because they thought they were useless. "There are multiple ways the Fed can go about getting to work in guiding inflation to 2%. The federal funds rate is the primary tool, but with the Fed’s balance sheet expanding, that’s not helping matters.

"The problem with the Warsh approach to monetary policy is that it could collide with the Treasury’s interventions in the bond market. The new Treasury-Fed Accord could be ‌more like a Treasury-Fed Discord. If Warsh wants to shrink the Fed’s balance sheet, that can work at odds with ‌the Treasury’s desire to mop up some of the longer-dated debt out there. "It’s been since 1939 when Chair Eccles dissented when we saw a Chair in the minority for a monetary policy move. It could be a matter of weeks before we see it again if Warsh argues for the Fed to stop expanding its ​balance sheet before it hikes rates."