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Kevin Warsh’s Jackson Hole speech signals a reluctance to promise policy, supports higher rates to tame inflation-raising dollar strength and pressure on emerging markets such as South Africa.
The annual Jackson Hole shindig for central bankers in the mountains of Wyoming has become a fixture in the monetary policy calendar. It is typically when Federal Reserve chairs step back from the monthly noise of economic data and explain how they think about monetary policy and the economy on a more philosophical level.
Some of these speeches have proven enormously consequential, changing the way investors see not just what will happen at the next interest rate meeting, but the direction of the Fed’s management of the economy itself.
Kevin Warsh’s first appearance as chair last Friday was less compelling. There was no new grand announcement on a shift of monetary direction.
But we did at least get some clarification regarding a fundamental issue which has clouded his first few months in the job: what does he think the Federal Reserve, the world’s most influential central bank, is actually there to do?
On this, he was rather clearer. His interpretation is not all that different from what previous holders of the position have understood.
Despite being torn between dual mandates, the Scylla and Charybdis of trying to achieve low inflation and full employment, his stance remains, after all, hawkish. He reiterated that the US is close to full employment while inflation remains stubbornly above the critical 2% target. That reality does not call for lax monetary policy.
The most important sentence in the speech was on this point. Warsh acknowledged that inflation data over the summer had been somewhat improved, but there was not enough data to suggest that the underlying reality of higher prices had changed meaningfully.
Markets reacted swiftly. Two-year Treasury yields jumped, as bonds sold off (yields move inversely to prices). Swaps markets moved to price in a greater-than-even probability of a rate hike in September. Investors are now having to deal with the reality that the most likely next move for US rates will be up.
In Pretoria at the Sarb, Lesetja Kganyago will not have missed the message.
A more hawkish Fed makes dollar assets relatively more attractive, supports the dollar and raises the hurdle rate for investors to consider investing in emerging-market assets such as SA. That can put pressure on the rand, push South African bond yields higher and reduce the room the South African Reserve Bank has to cut rates at home.
Elsewhere too, Warsh sounded hawkish. He rejected the idea doing the rounds in monetary policy debates that slowing real wage growth is a precursor to lower inflation. And he batted off the notion that strange labour dynamics in the US – where both hiring and firing have slowed due to the rise in immigrant deportations – have slowed markedly.
Putting all this together, Warsh’s reaction to data becomes easier to understand. Inflation remains too high. Employment and economic activity remain healthy. And some of the arguments used by monetary doves as reasons for cutting rates are, in his estimation, flawed. So plus ça change, plus c’est la même chose.
But the puzzle remains as to how he will intend to communicate all of this to investors over his tenure at the Fed. Undoubtedly, the most distinctive feature of his time in the role has been his commitment to what might be termed a “quiet Fed”, as opposed to the show-all-your-cards style of his predecessor, Jay Powell. He wants the central bank to speak less, forecast less and allow markets to do more work interpreting the economy, rather than obsessing over every utterance of Fed Open Market Committee members.
This is laudable. The Fed’s elaborate and bewildering jungle of forecasts, dot plots, forward guidance and carefully calibrated speeches has created an illusion that it somehow knows more than the rest of us as to where the economy is going. Its projections are inevitably incorrect. As a result, they muddy the already unclear waters.
Furthermore, this verbosity has in a sense meant that monetary policy has become self-fulfilling. If investors treat a forecast as a promise, policymakers can become reluctant to change course even when circumstances demand it. This was arguably what happened in the aftermath of the pandemic. When inflation soared, the Fed was adamant that such volatility was “transitory” and that it would come down of its own accord, refusing to shift its forecasts.
This proved to be disastrous. It was only in late 2021 that Powell relented and admitted that rates would have to be hiked to respond to the inflation following the insanely generous stimulus offered by the Biden administration. US, and indeed global, consumers are arguably still paying the price for this stubbornness.
This shift in communication strategy does make the next few weeks particularly consequential, especially what happens at the next September meeting. Heightening the tension is the utterly bizarre and shameful face-off with the US Treasury, where Scott Bessent seems determined to get long interest rates down, even though markets do not believe this is either merited or desirable.
Warsh at the Fed has made it clear that rising long-term rates are “desirable” in playing a role to getting inflation under control. His counterpart at the Treasury has stated precisely the opposite, and is conducting open market operations to this end.
Warsh is right that the Fed should make fewer promises, and that the gush of information coming out of this institution has made the job of investors harder, not easier. Let the market do what the market does. If he can achieve this, while keeping a steady hand on price levels, his pick by Trump may go down as this president’s most inspired decision.
Markets need to be left to function freely. If only his equivalent at the US Treasury could get the same message. DM
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