Warsh's Hawkish Pivot Risks Policy Error, Fed Credibility

Fed Chairman Kevin Warsh's recent hawkish pivot has raised concerns that he may be prioritizing credibility over proper monetary policy. In his Jackson Hole speech, Warsh pointed to 54% of the PCE's 199 components rising above 3% in the past year as evidence of broad-based inflation.

This choice of data is unusual given Warsh's previous dismissal of headline PCE as 'rough swag' and a 'scientific wild guess.' He had previously advocated for using trimmed-mean PCE, which removes volatile components, to gauge underlying inflation. The Dallas Fed Mean Trimmed PCE has been hovering around 2.3% for the last five months.

The bond market's reaction to Warsh's hawkish pivot has been positive, with rising rate-hike odds and a flattening yield curve. However, the risk remains that Warsh will back up his words with actions and support a rate hike at the September 16 FOMC meeting, potentially tightening rates when employment and inflation data don't justify higher rates.