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Federal Reserve Chair Kevin Warsh did not promise a September rate hike in his keynote at the Federal Reserve Bank of Kansas City’s annual Economic Policy Symposium in Jackson Hole. But his remarks may have given markets a clearer sense of how he is thinking about inflation and what could keep additional tightening on the table.

Warsh Reaffirms the 2% Target

“There should be no misunderstanding,” Warsh said in his August 28 speech. The Fed’s 2% PCE inflation objective is a “firm, fixed target.” He later said policymakers need to be confident that underlying inflation is moving toward that objective “clearly and at sufficient speed.” Otherwise, he said, “we have work to do.”

For markets, those comments appeared to reduce some of the uncertainty around how the new Fed chair may approach persistent inflation, a key consideration given that recent inflation data has shown limited progress. The Fed’s preferred gauge, core PCE, rose 0.2% in July and 3.3% over the 12 months through July, still well above the Fed’s 2% inflation target.

Warsh also pointed to the breadth of inflation pressures. In his speech, he noted that 54% of the goods and services in the PCE basket had risen more than 3% over the past year, compared with an average of roughly 32% in the two decades before the pandemic.

Taken together, the comments may suggest that Warsh may not yet view the recent improvement in inflation as sufficient to conclude that the underlying trend is securely headed back toward 2%.

Markets Appeared to Reprice the September Outlook

It seems the bond market responded quickly. According to CME FedWatch data cited by Reuters, the market-implied probability of a September rate hike rose to 55.7% following Warsh’s Friday remarks, up from 35.4% the day before.

Treasury yields also seemed to reflect a shift in expectations. The 2-year yield rose nearly 13 basis points to 4.36% by Friday’s close, while the 30-year yield rose only modestly.

That flattening of the yield curve may be one of the more notable signals from the week. Investors appeared to price in a greater likelihood of tighter Fed policy at the front end, while longer-term yields moved far less. One possible interpretation is that markets viewed a firmer near-term policy stance as supportive of longer-term inflation credibility.

The dollar moved in the same direction. The U.S. Dollar Index rose about 0.6% Friday, while gold fell more than 3%.

That combination looked notably different from the prior week, when concerns around fiscal and policy credibility had contributed to weakness in the dollar and long Treasuries alongside strength in gold. Warsh’s inflation-focused message appeared to reverse at least part of that move.

The Next Test May Be the Labor Market

The next question may be whether incoming labor data support the economic picture Warsh described.

At Jackson Hole, Warsh characterized the labor market as stable and “consistent with full employment.” The unemployment rate currently stands at 4.1%, while payroll growth has weakened materially. July nonfarm payrolls unexpectedly declined by 23,000, contributing to a broader picture of slower job creation.

That could put added weight on Friday’s August employment report, the final major payroll release before the September 15 to 16 FOMC meeting. Recent forecasts call for roughly 25,000 to 50,000 new jobs, with unemployment expected to remain near 4.1%.

Wages and Productivity Add Context

Wage growth will also be in focus. Average hourly earnings rose 3.2% year over year in July. The issue for policymakers may be less whether wages are keeping pace with inflation and more whether the nominal rate of wage growth, together with productivity, is consistent with inflation returning toward 2%. Warsh has described wage growth as “moderate” and noted that, on its own, it has not necessarily been a reliable predictor of future inflation.

Thursday’s revised second-quarter productivity and unit labor cost data may add context by showing whether wage gains are being matched by higher worker output, limiting the increase in labor costs per unit of production.

That could leave markets focused on a key question heading into Friday: Is the labor market holding up well enough to keep a September hike firmly in play?

A stronger-than-expected payroll report, steady unemployment, and firmer wage growth could reinforce expectations for additional tightening. Another weak report could make the September decision less clear.

A Broader Central-Bank Backdrop

The global backdrop may reinforce a similar theme of central-bank caution. Canada has a rate decision ahead, eurozone inflation data will be in focus, and markets in Asia will be watching Bank of Japan commentary and other policy decisions.

For U.S. investors, however, the near-term focus may be more concentrated on upcoming labor data.

Jackson Hole may have clarified Warsh’s inflation stance and increased the market-implied probability of a September hike.

Friday’s labor report could help determine whether that repricing holds.

“We see investors going to companies that can continue to earn despite the headwinds in rates and inflation. The quality factor is one that I think will continue.”

一Timothy Reilly, President

Private Markets, Public Questions 

Private equity and private credit are becoming more accessible, but access does not automatically make them a better fit. Morningstar looks at where private markets may add value, and where illiquidity, fees, valuation challenges, and manager selection can complicate the case.