Key Takeaways:
US equities edged lower Friday after Federal Reserve Chair Kevin Warsh said the central bank's inflation fight was not yet complete, lifting Treasury yields.
US stocks edged lower Friday after Federal Reserve Chair Kevin Warsh said inflation at 3.7 percent remains too high, lifting Treasury yields and pressuring equity valuations across the board.
"In short, we expect Warsh to signal that he is prepared to raise rates again if inflation does not continue to moderate," Mark Cabana, head of US rates strategy at Bank of America, said in a client note before the speech.
Warsh, delivering his first Jackson Hole keynote since taking office in May, said the Fed's preferred PCE inflation measure stands at 3.7 percent year-over-year, with the six-month reading near 4.1 percent. He said the central bank must be "entirely confident" that core inflation is heading toward the 2 percent target, warning that "serious action" would follow if that does not occur. The Fed has held rates between 3.5 percent and 3.75 percent since July, when three voting members dissented in favor of a quarter-point increase.
The hawkish tone raises the stakes for the September Federal Open Market Committee meeting, where markets currently price a 66.3 percent probability of no change and a 33.7 percent chance of a rate increase. Higher bond yields increase the discount rate on future earnings, hitting growth and technology stocks hardest.
Warsh said the economy has "generally strengthened," citing corporate capital spending up about 9 percent over the past four quarters and S&P 500 earnings growth above 20 percent in the past year. He described the labor market as "generally good" with unemployment at 4.1 percent, but said the picture of price stability is "more worrying." Over the past 12 months, 54 percent of goods and services in the PCE basket recorded price increases above 3 percent, compared with 32 percent in the two decades before the pandemic.
The Fed chair also used the speech to outline a shift away from forward guidance, arguing that pre-committing to future rate decisions "can create ambiguity instead of clarity." He warned of a "Hall of Mirrors" problem where markets rely on Fed guidance while the Fed relies on market prices, potentially leading to policy errors. Warsh said the greatest cost of this dynamic would fall on Americans who do not own significant financial assets.
Treasury Buybacks Add Pressure
Warsh's remarks come as the Treasury Department doubles its buyback operations on off-the-run debt, a move that some economists said undermines the Fed chair's market-driven approach. The 10-year Treasury yield rose after the speech, with Bank of America warning that a dovish interpretation could push the 30-year yield above 5.5 percent. S&P 500 futures traded slightly below flat levels before the address, while Nasdaq 100 futures declined 0.3 percent.
In crypto markets, Bitcoin traded at $79,615, up 2.3 percent over seven days, while Ethereum gained 4.6 percent to $2,503 and Solana rose 15.7 percent to $105.57.
The next test for markets is the September FOMC meeting, where policymakers will weigh whether inflation data supports another hold or a hike. Cleveland Fed President Beth Hammack has already called for immediate rate increases, saying "now is the time to act." Markets will also watch for the next PCE inflation reading, due in the weeks before the meeting, to gauge whether the summer's better-than-expected data represents a genuine trend or a temporary reprieve.
This article is for informational purposes only and does not constitute investment advice.
