Kevin Warsh, the new Chair of the Fed, delivered his first major speech at Jackson Hole. And remember something very important: this is the man Trump appointed. And he appointed him with one very specific expectation: to cut interest rates.
So what did Warsh do? He talked about the exact opposite.
Within just a few hours, the probability of the Fed raising interest rates in September jumped from 35% to 55%. And bond markets immediately began to move.
The sentence that changed everything was this:
"We need to be confident that underlying inflation is moving toward our target, clearly and with sufficient speed. Otherwise, we have work to do. That is our job."
"We have work to do." It sounds innocent, but it isn't.
In central banker language, that means one thing and one thing only: higher interest rates.
And notice something else. Inflation data over the summer came in better than expected, both the PCE and the CPI. Logically, Warsh should have been pleased. Instead, he said that these numbers "do not tell me that the underlying trends have improved meaningfully."
What does that mean? It means that two or three good months are not enough to convince him. He wants to see a sustained trend.
He also made it clear that the 2% target remains unchanged and that it is measured using the PCE. And that matters, because in July he had hinted that the target might change, which had scared everyone.
Right now, PCE inflation stands at 3.7%. It has remained above the Fed's 2% target for roughly five and a half years. During his speech, the word "inflation" was mentioned 25 times. Yes, you read that correctly. Twenty-five times.
And this is where things get even more interesting.
Warsh said he would find it very difficult to describe current financial conditions as "restrictive."
"What does that even mean?" you may be asking.
Put very simply, when interest rates are high enough, money becomes expensive. Businesses borrow less, people spend less, and inflation falls. That is what is known as "restrictive monetary policy."
And Warsh is saying that this is not happening right now.
And he has arguments to support that view. Credit spreads are tight. Bond issuance is strong. Banks are lending easily. Corporate earnings are strong, and the stock market is rising. Unemployment stands at 4.1%. Real consumption has increased by 2% over the past year. And AI investment is growing at a pace we have never seen before.
In other words? The economy is not hurting at all. Therefore, interest rates are not high enough.
And here we can see another important shift. In July, the Fed had said that high long-term interest rates were already doing the job on their own. Now, Warsh is saying the opposite.
The second major part of the speech was more structural.
Warsh wants a "quieter Fed." He does not want to tell markets what the Fed will do. Or when. Or under what conditions.
You might ask why.
His argument is that when you make public commitments, you lose flexibility. He even pointed to 2021 as an example, when the Fed's previous commitments delayed its response to inflation.
"When we make commitments about interest rates, we constrain our own freedom to make the right decision when the time comes," he said.
And when he was asked to provide at least a "reaction function," he responded that the economy is far too complex for mathematical formulas such as the Taylor Rule.
And here is the irony. By saying that he will act if inflation does not fall "clearly and quickly," Warsh gave the market exactly what it wanted: guidance. He just didn't call it that.
From this point on, there are two specific dates we are watching.
September 11: August CPI data will be released. If inflation comes in lower than expected, the discussion about a rate hike will likely fade. If it comes in higher, it could lock in expectations for one.
September 15-16: The Fed holds its policy meeting.
Barclays and Societe Generale expect a 0.25% rate hike in September and a second one in December. Evercore ISI has also changed its position. Loretta Mester, former president of the Cleveland Fed, put it clearly: "The burden now falls on those who want to stand still."
And what does the other side say? Joseph Brusuelas of RSM raised the most reasonable question: "If he sees inflation as unacceptably high, why didn't he raise rates at the July 29 meeting?"
And let's not forget politics. The US midterm elections are coming up in November. And Trump wants cheap money. Stephanie Roth of Wolfe Research puts the odds of a September rate hike below 50-50, precisely because of that relationship.
Internationally, however, the speech was well received. Andrew Bailey of the Bank of England described it as "a speech of real substance." And Kristalina Georgieva of the IMF praised the commitment to the 2% target.
