Federal Reserve Chair Kevin Warsh started his fight against inflation with jawboning during June’s decision on monetary policy. The performance was all words, many task forces, and no action. Warsh doubled down on the jawboning for July’s decision. The Chair expressed even more resolve for hitting the 2% inflation target while making the measuring stick provisional. PCE remains the benchmark for now, but Warsh suggested the task forces could change that strategy after January and declined to identify the broader set of inflation data informing his judgment.

Warsh doubled down on jawboning by describing a contentious policy meeting while also sidestepping a request to explain the decision to hold rates unchanged. Warsh also refused to provide any insight on the dissent from the three of twelve voting FOMC members who each voted for a quarter-point rate hike (Beth M. Hammack, Neel Kashkari, and Lorie K. Logan). He even declared as a counterpoint that there was “a lot of agreement on the hard questions.” He also heard a lot of “commonality” on the key questions he mentioned at the top of the press conference; the answers just had different “leans.”

Finally, Warsh further extended his brand of opaque Fedspeak by countering the image of a Fed fighting over rate hikes with the unanimity on a metaphorical vote for a period of “watchful thinking not watchful waiting.” In either sense of watchfulness, Warsh did not provide specifics about what the Fed is actually prepared to do to finally bring inflation back to target.

The statement itself made the decision to hold rates steady even harder to explain. The FOMC described economic activity as expanding at a solid pace, productivity and capital investment as strong, job gains as keeping pace with the workforce, and unemployment as little changed. At the same time, inflation remained elevated. Yet, the Committee offered no explanation for why this combination of solid growth, stable employment, and above-target inflation justified leaving rates unchanged. Instead, the statement jumped from attributing some price increases to supply shocks straight into more jawboning: “The Committee will deliver price stability.”

Warsh’s declarations about inflation were all the more awkward given he continued to imply that the Fed before his tenure was not serious enough about its inflation target. For context, Warsh consistently describes inflation as a choice, a claim predating his appointment to the Chair. However, he has yet to specify the choices the Fed needs to make beyond the potential recommendations from his various task forces. Instead, he is keen to point out distinctions between the current FOMC and prior ones: “we have begun a new chapter, and we understand that the five-plus years of inflation above target cannot be cured in nine weeks—or by a single month of modest price decreases.”

Warsh introduced one more potential choice without making it specific: the balance sheet. He asked how much accommodation it is still providing even if interest-rate policy remains the Fed’s primary instrument. As with the inflation framework, Warsh posed the question without providing an answer, an intended adjustment, or a timetable.

Passing the Inflation Fight to the Bond Market

One emergent choice could be passing the inflation-fighting baton to financial markets. In his opening statement, Warsh anticipated questions about what the Fed did to fight inflation between the June and July meetings. He pointed out that the Fed’s retreat from the business of forecasting and forward guidance allowed financial markets to react to data instead of the Fed. The result? Higher bond yields that have tightened financial conditions. He used a sports metaphor to emphasize the change in the game: “market participants are learning to play the ball, not the referee—and market prices will continue to respond in the direction and magnitude they see fit.”

While Warsh insisted that “where necessary and appropriate, we will not hesitate to act,” he declined to clarify the conditions under which the FOMC would actually do something about inflation. Still, toward the end of the press conference, Warsh acknowledged that the bond market’s tightening of financial conditions provides “some comfort that we’ve got the ability and capability to deliver.” The coded language suggests that the Fed is willing to let the bond market do part of the inflation-fighting work while the FOMC waits for results.

One perplexed reporter pointed out that the bond market’s higher rates suggested the Fed was falling behind on hiking its own rates. Another befuddled reporter bluntly asked, “Why should rates not be higher today?” Warsh deftly avoided referencing the Fed funds rate and instead chose to point out the “market’s judgement” to take nominal rates higher along the Treasury curve. While the Fed will not allow the market to dictate its actions, the Fed is “observing” markets.

Warsh next pointed out that both the Fed and markets have upcoming decisions to make about interest rates. He tried to make it plain: “Monetary policy matters not just by what we say, or even what we do. Monetary policy matters by how it affects the real economy.” Of all the Warshspeak on the day, that statement stood out to me as the clearest declaration of the Fed’s modality for action in the Warsh era. If the Fed concludes that market is tightening financial conditions in response to inflationary pressures, the Fed will be content to wait for inflation to respond accordingly.

The Bond Market Hears Warsh Loud and Clear

The bond market seemed to get the point. Long-duration Treasury bonds sold off sharply as soon as the Fed’s statement hit the wires and barely stopped to catch a breath for the rest of the regular trading day.

The reaction function for stocks was much more volatile. The S&P 500 (SPY) rallied into and through the statement until someone tapped stocks on the proverbial shoulder and turned attention to the bond sell-off. The S&P 500 sold off sharply in the last hour of trading, falling from a marginal 0.4% gain intraday to a 1.5% loss at the close.

The subtle frustration from the press intensified with every unanswered question. One reporter almost pleaded with Warsh. The reporter pointed out his repeated claims about intolerance for above target inflation while his Fed has yet to take action. In response to the reporter’s request to clarify what he means by “no tolerance for inflation” and the plans to act, Warsh responded by acknowledging the impatience he had heard about this situation. Yet, he still only offered the same menu of jawboning by declaring this Fed is “on the job. We will deliver.” First, the Fed needs to answer a series of hard questions in order to deliver on its remit.

The press’s frustration symbolically boiled over in the last question: “You said you’d be open to having press conferences when there’s news to make. Today, no change in rates. No forward guidance. For the average household, what was the news today?” Warsh’s final non-answer was telling. Warsh first reiterated his commitment to the existing press conference schedule for 2026. He went on to assure the audience that the Fed is “on the case”, and his confidence in the Fed’s ability to deliver on its inflation target was even stronger than when he took the Chair position. He concluded the session by leaving the audience with “the optimism of a new central banker that we’re committed as ever to deliver and to offer an assurance we will.” And with that doubling down, the jawboning came to an end.

Be careful out there!

Full disclosure: long TLT

The post Warsh Doubled Down On Jawboning Even As the Fed Fights Over Rate Hikes appeared first on Inflation Watch.

I faded the move in bonds as nothing about the December CPI print changed the fundamental narrative of sticky inflation and a cautious Fed or even the prospect of soaring U.S. budget deficits. I speculated on weekly SPY put options as a hedge. I fully acknowledge that the stock market has spent a year and a half or more adjusting to every hiccup and bout of angst over the inflation narrative.

The chart below demonstrates that the eye must strain hard to see a change in the profile of core CPI. We will have to wait until later this month to see whether the softer than expected core CPI also bends core PCE off its uptrend from its last trough.

Sources: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis; January 15, 2025.

The volatility index (VIX) well represented the stock market’s huge sigh of relief over inflation. The VIX plunged 13.9% and brought an end to the most recent uptrend.

Shelter Inflation Continues Trending Down

Shelter inflation, along with services inflation, has been a key culprit in stubbornly sticky inflation. The National Association of Home Builders (NAHB) pointed out that “the year-over-year change in the shelter index remained below 5% for a fourth straight month and posted its lowest annual gain since January 2022, suggesting a continued moderation in housing inflation.” Shelter inflation has even been on a definitive downtrend since peaking in March, 2023. Unfortunately, the current trajectory may be too slow for comfort in terms of its impact on aggregate core CPI.

Shelter inflation dropped from 7.5% in December, 2022 to 6.2% in December, 2023 and now 4.6% last December. If this nearly linear pace continues, shelter inflation will be around 3.2% next December, right around where core CPI currently sits. Thus, other components will still need to do some heavy-lifting in coming months to meaningfully push core CPI, and presumably core PCE, closer to the Fed’s 2.0% target.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Shelter in U.S. City Average [CUSR0000SAH1], retrieved from FRED, Federal Reserve Bank of St. Louis; January 16, 2025

An Oil Breakout

Oil prices are not part of the core CPI, but its recent breakout has caught my attention. A continued, persistent rise in oil prices could bleed into higher inflation expectations for consumers. Such a dynamic may further motivate the Federal Reserve to sit on its hands with monetary policy. A 3.3% gain in the United States Oil Fund (USO) sent the ETF to a 2 1/2 year high.

A Spike In Short-Term Inflation Expectations?

Every month, the New York Federal Reserve publishes a survey of consumer expectations. This survey includes various measures of inflation expectations. The 1-year median expected inflation rate for consumers stayed around 3.0% for all of 2024, consistent with the narrative of sticky inflation. However, a potentially interesting blip happened in December where the median point prediction jumped from 3.0% to 3.8%. The median point predictions are typically higher than the median expected inflation rate, but they rarely diverge and almost never by such a wide margin. The accompanying press release does not refer to this surprising 1-month behavior, but I cannot help speculating on its significance. I will be watching to see whether this point projection manages to lead the median expected inflation rate higher or whether it snaps back to the typical relationship. Either way, such a jump is surely not positive for inflation in the near-term.

The Trade

I continue to maintain a strategy of fading rallies in TLT. Going into the CPI I owned a single February TLT $85 put option “just in case” CPI produced a fresh upside surprise in inflation. Now I can accumulate TLT put options at more attractive prices. TLT’s rally stopped just short of resistance at the 20-day moving average (DMA) (the dotted line below). A breakout from there will set up even more attractive prices on a test of converging resistance between the downtrending 50DMA (the red line) and the bottom of the former trading range (the thick black line).

Be careful out there!

Full disclosure: long TLT put options, long SPY put options

The post A Fresh Opportunity to Fade Bonds As A Marginal Change in Inflation Ignites A Near Oversold Market appeared first on Inflation Watch.

I am tempted to say financial markets have already done the Fed’s work. However, it is very likely that the minute the Federal Reserve even hints that rate cuts could be delayed until next year, the resulting tantrum in financial markets could be epic. The Fed is loathe to disappoint markets, and the message from the last meeting and subsequently from Jerome Powell has been to promise a rate cut sooner than later. Financial markets have persistently focused on any and all dovish twinges in Fed-related pronouncements. For example, from Powell’s testimony to Congress on March 6th (emphasis mine):

“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2 percent. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

Powell can insert all the standard caveats he wants. Markets read this statement as saying rate cuts are on their way!

A Nervous Bond Market

Yet, bond markets have been a little “nervous” all year. For example, the iShares 20+ Year Treasury Bond ETF (TLT) has trended downward (meaning higher bond yields) so far this year with lower highs and lower lows. From TradingView:

TLT is just a fresh low of the year away from finally catching the stock market’s attention again.

Copper, Lumber, and Oil – oh my!

The bond market has good reason for some jitters. Several commodities have sprung back to life this year. Copper miner Freeport-McMoRan Inc (FCX) is welcoming the upcoming Fed meeting with a 7+ month high. FCX is up 19.8% in less than two weeks. (FCX has been stuck in a trading range since the beginning of 2021).

Lumber bottomed out in early 2023. This month, lumber broke out above last summer’s high and is back to levels last seen in August, 2022.

Oil, everyone’s favorite non-core component of inflation, has been in “stealth” rally mode all year. The United States Oil Fund, LP (USO) looks ready to launch parabolically on the wings of rate cuts.

Where will these prices go with rate cuts? I vote higher.

The Golden Touch

Speaking of getting ready for rate cuts, gold, my favorite hedge enjoyed a spectacular (and overdue) breakout this month. SPDR Gold Shares (GLD) traded at an all-time high at its peak this month.

I like buying the dips in GLD going forward. The odds seem sufficiently high for the Fed to feel “forced” into easing into a sea of market liquidity.

Straining to See the Weakness in Labor Markets

So maybe the Fed can strain its economic gaze and find an excuse to do a “proactive” rate cut. The graph below shows the unemployment rate has likely bottomed out (left axis and blue line) Yet, it remains near historic lows. Initial unemployment claims have been trendless with a recent peak set last summer (right axis and green line). Finally, real GDP quarter-over-quarter growth has levitated in positive territory and for the last two years has defied overly persistent expectations for a recession (right axis and red line). From my perch, I see no excuse for a rate cut here, but perhaps I am not creative enough with the data.

Sources: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis.

The Stock Market’s Giddy Anticipation

The stock market’s giddy anticipation of rate cuts is poetic. The stock market has soared on loosening financial conditions and has been able to ignore just about any bad news the macro environment tries to toss out there. Recent successive all-time highs speak volumes to the buffer the Fed can enjoy if it so chooses to wait out the Presidential election before making changes to monetary policy.

Conclusion

With market breadth increasingly lagging the stock market’s ascension, I have been a skeptic about the overall rally for several weeks. The Federal Reserve is probably the last catalyst between now and the Presidential election that has a chance of validating my skepticism. If the Fed complies with the market’s giddiness, there is no telling how high the market could soar in coming months. If the Fed decides to wait things out, the stock market will lose a major contributor to the upward and higher fund. Then again, maybe the Fed pulls off a magical “hawkish rate cut” (one and done rate cut with a warning about the potential for inflation to rise from the ashes). The Fed could figure out just the right balance between disappointing the stock market and fueling ever increasing levels of speculation and higher commodity prices…

Be careful out there!

Full disclosure: long GLD

The post Financial Conditions Make A Monetary Roundtrip and Undercut the Need for Rate Cuts appeared first on Inflation Watch.

• The Fed’s revised monetary policy framework in 2020 contained an inherent inflationary bias.
• The Fed relied too heavily on hawkish hints in the months leading into the lift-off for monetary policy.
• The Fed recognized too late that the labor market was sufficiently tight for higher rates.

Powell made no mention of any of these factors in his Jackson Hole speech. Instead, Powell provided a one sentence summary of the inflation narrative: “The ongoing episode of high inflation initially emerged from a collision between very strong demand and pandemic-constrained supply.” Even in describing the path to lower inflation, Powell avoided saying that the Fed needs to unwind overly accommodative monetary policy: “By the time the Federal Open Market Committee raised the policy rate in March 2022, it was clear that bringing down inflation would depend on both the unwinding of the unprecedented pandemic-related demand and supply distortions and on our tightening of monetary policy.” Inflation has to unwind itself along with the assistance of tightening policy.

Powell went on to provide a very familiar narrative about inflation:

• The Russian invasion of Ukraine has driven up headline inflation.
• “Demand for vehicles rose sharply, supported by low interest rates, fiscal transfers, curtailed spending on in-person services, and shifts in preference away from using public transportation and from living in cities. But because of a shortage of semiconductors, vehicle supply actually fell.” At least Powell acknowledged low interest rates helped drive excess demand for vehicles.
• “In the highly interest-sensitive housing sector, the effects of monetary policy became apparent soon after liftoff. Mortgage rates doubled over the course of 2022, causing housing starts and sales to fall and house price growth to plummet. Growth in market rents soon peaked and then steadily declined.” Here Powell chose to focus on the impact of higher rates on housing which of course implies that lower rates supported housing demand. He avoided noting how unnaturally low interest rates drove the housing market to mania levels of demand and pricing.
• “Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight.” Nonhousing services inflation presents the Fed with its most troublesome driver of inflation. Powell noted that inflation in this sector has “moved sideways” since monetary tightening began.

A stronger than expected economy is the upshot to the current inflation story. This above trend economic growth could force the Fed to continue hiking rates higher and for longer than current expectations. In fact, this economic strength is the exact opposite of what so many economists, pundits, and analysts have expected for 18 months or so. The most anticipated recession in U.S. history just refuses to materialize.

The current uncertainty leaves financial markets nervous. The U.S. dollar (DXY) is stronger than expected at this part of the cycle, the entire rate curve is moving higher, and the stock market looks wobbly. The NASDAQ (COMPQ) and the S&P 500 (SPY) have returned to their last highs preceding Jackson Hole 2022. What I have called the “summer of loving stocks” has already lost all its gains from July. August is just the first month of the three “most dangerous” months in the stock market. So even as the stock market approaches oversold trading conditions, obligatory rebounds may be insufficient to stave off a rollback of all the summer gains.

The S&P 500 (SPY) is confirming a failure at 50DMA resistance on its way to what looks like a more direct test of support from the high prior to Jackson Hole 20222.

The iShares 20+ Year Treasury Bond ETF (TLT) is challenging its lows from October and November. A further breakdown could trigger a fresh wave of selling in the stock market.

Be careful out there!

Full disclosure: long TLT put spread

The post What Powell Missed In His Jackson Hole Speech Explaining Inflation’s Drivers appeared first on Inflation Watch.