Warsh's Rate Decision Sparks Credibility Shock on Wall Street

Newly appointed Federal Reserve Chair Kevin Warsh is facing skepticism from Wall Street after his latest rate decision, sparking what Bank of America's U.S. economy team calls a 'credibility shock.' The Fed held rates steady in July, with Warsh refusing to specify what would trigger a hike, fueling speculation that he might not be willing to raise them at all.

Warsh later clarified his stance during a keynote speech at Jackson Hole on August 28, calling the Fed's 2% inflation target 'firm' and 'fixed,' while acknowledging that inflation was running higher than expected. This hawkish signal from someone who has vowed to give the market fewer signals before policy decisions has left investors wondering what's next.

The Fed's next decision is set for September 16, with prediction markets putting the odds of a rate hike at near 60%. One potential consequence of Warsh's actions is that inflation hedges like gold may become more attractive to investors. The SPDR Gold Shares ETF (GLD), which tracks spot gold, has closed 18% below its January 29 all-time high and could see further gains if the market loses faith in the Fed's ability to tame inflation.

Additionally, bond markets are already pricing in higher long-term borrowing costs, with interest rates on debt like mortgages and corporate debt trending higher than the federal funds rate. This suggests that investors expect inflation to continue running high, at least for now.