Warsh's Inflation Warning Sparks Rate Hike Fears Ahead of Weak Jobs Report

Fed Governor Kevin Warsh's recent speech at Jackson Hole has sparked renewed concerns about inflation and the potential for interest rate hikes. Traditionally, this annual event is where the Fed Chair signals which economic forces are shaping their thinking for the coming year. However, with some members pushing for rate hikes and others anxious, markets are taking Warsh's speech as an indication of what the Fed may do at its next few FOMC meetings rather than its 2027 outlook.

Warsh was blunt in his assessment of inflation, signaling that the Fed may not be done fighting it. He stated that financial conditions didn't look restrictive enough to him and that recent benign inflation readings hadn't convinced him that the trend is improving meaningfully. According to Warsh's speech, 'And while this summer's PCE and CPI readings were better than expected, they do not tell me that underlying trends have meaningfully improved.' He emphasized that the Fed's job is to be confident that underlying inflation is moving towards its objective at a sufficient speed.

Warsh backed up his concerns with data, pointing out that the core PCE price index sits at 3.7% year over year, with core measures also elevated. He disaggregated all 199 components of the basket and found that 54% of goods and services rose above 3% over the past year, down from post-pandemic highs near 77%, but still well above the 32% average of the two decades before the pandemic.

The market reaction to Warsh's speech was immediate, with longer bond yields falling and shorter yields rising, flattening the yield curve. This is what a credible inflation-fighting message would be expected to do: reassure long-duration holders while raising the odds that the Fed holds or hikes at its next meeting rather than cuts.