Federal Reserve Chair Kevin Warsh arrived in Jackson Hole last week with something to prove.
His performance following the July FOMC meeting left markets wanting more. After more than five years of inflation running above the Fed's 2% target, investors were looking for evidence that the new Fed Chair understood the assignment and that his commitment to restoring price stability amounted to more than words.
At Jackson Hole, he delivered.
Warsh stopped well short of committing to a rate hike at the Fed's September meeting, but the overall message was decidedly more hawkish. He said he would be "hard pressed to describe broad financial conditions as restrictive," pointing to a relatively healthy labor market, strong corporate profits and tight credit spreads. In other words, the economy appears strong enough to withstand additional monetary tightening if that's what is required to bring inflation back under control.
We've now had back-to-back months of better-than-expected inflation data, which is encouraging. But Warsh made clear that he isn't yet convinced those reports represent a meaningful change in the underlying trend.
One thing I appreciated about the speech was that he gave investors more insight into how he thinks about inflation. Rather than focusing exclusively on headline readings, he also looks at how broadly price increases are occurring throughout the economy.
Over the past 12 months, 54% of the goods and services in the PCE basket have experienced price increases greater than 3%. During the two decades before the pandemic, that figure averaged just 32%. Inflation has clearly improved, but price pressures remain considerably more widespread than they were before COVID.
Markets clearly interpreted the speech as hawkish. Before Jackson Hole, futures markets were pricing roughly a one-in-three chance of a September rate hike. Following Warsh's remarks, those odds moved to roughly 58%, meaning the market now slightly favors another hike in September.
But I think there's a bigger takeaway for investors: Kevin Warsh looked much more like a Fed Chair at Jackson Hole.
His July press conference can probably be chalked up to growing pains. Last week's speech was more disciplined and substantive, and it gave investors a clearer framework for understanding how he intends to make monetary policy decisions.
More importantly, Warsh appears committed to doing what is necessary to bring inflation back to 2%, even if that puts him at odds with an administration that would prefer lower rates. After a shaky start in July, that should help restore some confidence in the Fed's credibility.
Attention now turns to Friday's August employment report. Hiring has slowed, but unemployment remains low and there still isn't much evidence of broad-based layoffs or serious deterioration in employment.
The key question is whether the report shows any meaningful weakening in the labor market. Absent that, the Fed's attention can remain squarely on inflation. And after Jackson Hole, investors should have a little more confidence that Warsh is prepared to do something about it.
Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA®), a CERTIFIED FINANCIAL PLANNER™ (CFP®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio.
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