A Fed Family Fight

Last month Federal Reserve Chairman Kevin Warsh said he would welcome a “good family fight” about monetary policy, and he got one.

The Fed left interest rates unchanged this week, but three of the 12 voting members dissented in favor of a rate hike.

Warsh's second press conference as Fed chairman was somehow limited in its messaging while still carrying a lot of weight. Here are a few of my key takeaways from this meeting.

The Target Is the Target

Warsh tried to dispel the myth that the Fed's 2% inflation target is a soft target. Because inflation hasn't fallen that low for many years, some people believe it's only a loosely held target, but Warsh said there's no tolerance for running above it. When asked which inflation metric the Fed compares to the target, he didn't give a definitive answer. The chart below shows a number of inflation metrics… and none of them are at 2%.

Given the strong commitment he expressed, markets seem perplexed as to why the Fed didn't hike rates. My personal opinion is that holding rates steady was the right decision, but the messaging didn't clearly outline why the Fed thought that was the right decision.

Forward Guidance Is Dead

Warsh made it clear again that the Fed will not be providing forward guidance. Warsh also acknowledged that part of what caused Treasury yield volatility since the last Fed meeting was the lack of forward guidance. In other words, he realizes that eliminating forward guidance is going to take some getting used to and markets need to learn to “play the ball, not the referee.” (Historically, the Fed was the referee.)

I respect his ability to withstand market volatility in the short-term in the name of changing the Fed's approach. The market, particularly the Treasury market, is not going to be so patient.

In reaction to the Fed keeping rates unchanged, the 2-year Treasury yield fell signaling that the market was expecting a hike today and needed to readjust. But the 10-year and 30-year yield rose, signaling that inflation is still a concern and the market expects hikes in the future.

The result was a steepening yield curve (the difference between short-term yields and long-term yields grew). In some respects, the rise in long-term yields tightens financial conditions by making capital more expensive. And in other respects it suggests that inflation expectations are moving higher, which is not what the Fed wants.

This Fed meeting was a great example of how uncomfortable markets are with uncertainty. Removing forward guidance creates more uncertainty, and uncertainty creates volatility. In a way, a rate hike may have been embraced simply because it was a clear move. I think that would've been a foolish reaction, but markets are not always logical.

We are now left to wait until the next Fed meeting on Sept. 16. The market sees the probability of a hike as greater than 50% right now, but things will likely change a lot between now and then.

Until a couple weeks ago, I was on the side of “no hikes in 2026,” but I'm starting to believe that hikes are genuinely possible this year if inflation doesn't show meaningful progress downward, and fast. As long as oil prices remain elevated and demand for AI outstrips supply, that's not happening. I do not want any rate hikes, but I'm warming up to it as a potential reality.

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