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 11 basis points to 4.34%, its highest in a month. The 10-year Treasury yield was up 5 basis points at 4.72% and the 30-year Treasury yield was up 1.6 basis points at 5.206%. U.S. stocks were mixed early in the afternoon on ​Friday, with the Nasdaq off 0.3%, while the U.S. dollar index rose 0.6% to 99.66, again reflecting expectations that rates will rise. The rates market was showing a 60% chance of a rate increase next month, up from 35% before the speech, according to CME data.

COMMENTS: NATHAN SHETTY, CHIEF INVESTMENT OFFICER, SEI INVESTMENTS, OAKS, PENNSYLVANIA:

"Ultimately he reaffirmed the 2% PCE target is firm, and I think this provided some additional clarity to the market. "I don't think ​you can really interpret this as any other way other than a more hawkish tone.

"We've been in the camp where the market was underpricing Fed action." ELLEN HAZEN, CHIEF MARKET STRATEGIST AT F.L. PUTNAM INVESTMENT MANAGEMENT, LYNNFIELD, MASSACHUSETTS:

"He did not disclose anything about the Fed's reaction function and so that ‌means that the market is still in the ​dark. But the one thing he did do is he gave a little bit more rationale for that. He said, basically, in so many words, if you disclose your reaction function, it ends up tying your hands. And the outcome might have been different if in 2021, the Fed hadn't tied its own hands with forward guidance in disclosing the reaction function. So the inference is that they want to remain more nimble, that's a decent rationale. I don't think the market loves that, but it's fine. "The other thing he really talked about that I thought was interesting is saying that, by the way, if the Fed makes a mistake, it's the low end of the K that suffers. It's not the high end of the K. And so he's trying to cloak his decision to remove forward guidance and not discuss the Fed's reaction function in the mantle of service to the lower-end consumer. So that is interesting, it will swat away some of the critiques of his decision.

"The one thing I was kind of surprised that he said or that he didn't say was that he didn't talk at all about Fed independence, and he didn't talk at all about the recent Treasury moves, and I thought those were very much top of mind for a lot of people. So he could have taken this opportunity to do that. He really didn't, but he was very clear - financial conditions are not restrictive, underlying inflation trends have not meaningfully ‌improved. So I think it's clear he's setting up for a hike, but I think he's going to use the task forces as a rationale for delaying any move until after the midterms." ROBERT PAVLIK, SENIOR PORTFOLIO MANAGER AT DAKOTA WEALTH IN FAIRFIELD, CONNECTICUT:

"The speech overall was in between hawkish and dovish. He did say inflation was running above 2%. He didn't say or imply that a rate hike was imminent. That's giving relief to stock investors right now." PETER ANDERSEN, FOUNDER OF ANDERSEN CAPITAL MANAGEMENT IN BOSTON: "There was a lot of anticipation for it because, of course, it's the Fed chairman's first address in that nature, in that setting. And to be honest, I think investors were looking for a GPS on the economy, and instead, the Fed gave them a compass... they wanted far more details than he gave them. "And I think it really is sending a clear message to the market that we are in the new regime of a Fed, a Fed that is not going to provide guidance, is not going to be overly communicating with the investment public, and the market needs to get calibrated to that new regime. "The message is quite pointed and very different from, say, the past several Fed chairs. So I would expect a little bit of more volatility over the coming weeks until investors get used to this as the new regime."

BRIAN STOREY, SVP OF MULTI-ASSET STRATEGIES, BRINKER CAPITAL, KING OF PRUSSIA, PENNSYLVANIA: “Although Chairman Warsh expressed his views predominantly in terms of larger principles and did not hand the market his detailed ‘playbook’ on setting interest rate policy, I think the speech did provide some assurance to bond markets. First, he reaffirmed a commitment to price stability in the form of a 2% level for the PCE; secondly, he acknowledged that price trends -- while improving -- were not showing enough improvement; and finally, he unequivocally placed the responsibility and accountability for maintaining price stability on the shoulders of the Federal Reserve.

“I think Chairman Warsh’s objective was to further explain the rationale for his belief that a quieter Fed is a better Fed instead of acquiescing ‌to those who wanted him to be more granular or in the weeds about his reaction function. He doubled-down on his belief that less forward guidance from the Fed will lead to better outcomes and that market participants should rely more heavily on market indicators than the Fed in making their decisions. In this regard, he did not give the market clarity on key indicators or data points that will inform his views on interest rate policy, but he did try to frame his views for the markets in terms of core principles that will govern his time as Chair of the Federal Reserve. “Our view is that Chairman Warsh positioned this speech as an explanation for standing pat on rates at the most recent FOMC meeting and to also provide cover if the decision at the next FOMC meeting is to keep the Fed funds rate unchanged. That said, the tone of the speech definitely leaned hawkish, and markets seemed to ‌think so as well, with the 2-year Treasury yield moving higher and the odds of a rate hike at the September FOMC meeting increasing during Chairman Warsh’s speech.”

DENNIS DICK, FOUNDER AND MARKET STRUCTURE ANALYST AT TRIPLE D TRADING IN BARRIE, ONTARIO: "It's 50-50. We didn't really get a clear signal here today. We're not seeing a huge response here because I don't think we got a clear signal on whether they're going to go and hike in September or not.

"AI in itself is going to be deflationary. And that's actually going to help a lot of the problems. So, if we do get a rate hike or two, it's one or two and that's it, even with the deficit with $40 trillion in debt. "But I'm not even sure they're going to hike at all. So, I'm in the opinion where I think there's still uncertainty here, but I'm kind of leaning more towards the side that they might just steady as she goes.

"Like, I mean, the jobs haven't fallen off a cliff; the economy seems to be doing well; inflation is not completely in check. On a worst-case scenario for the markets for interest rate outlooks, one or two hikes. Longer term, I think interest rates actually go lower. If I'm guessing a year from now, I think we're talking about lowering interest rates and not raising interest rates. So, I'm not overly concerned about, you know, the short-term hiccup. Can the market sustain a one or two-rate hike? Sure." 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."