Warsh focuses on inflation; no guidance on future rates

Summary

Inflation remains the first priority

In laying out his key monetary policy principles, Warsh described the Fed’s 2% PCE objective as a “firm, fixed target” and warned against assuming inflation will simply reverse on its own. He said that unless inflation is clearly moving toward target at a sufficient pace, the Fed has “work to do.” Warsh appears to have dismissed some of the recent improvements in the inflation data, especially in light of a stated view that the economy is running at full employment. Twelve-month headline PCE inflation is 3.7%, and core PCE is at 3.3%, and price increases remain broad including areas traditionally running at deflation, such as electronics. Unemployment is 4.1%, business investment and consumer spending remain resilient, and broad financial conditions do not appear restrictive, particularly in light of near all-time highs in equity markets and low credit spreads. These conditions give the Fed room to keep inflation at the center of its near-term focus.

Warsh was equally clear about what investors should not expect: a prescribed rate path. He argued that routine forward guidance has “overstayed its welcome.” When investors trade on Fed signals and policymakers then treat market prices as independent evidence, both can become trapped in what he called a “hall of mirrors.” His alternative is clear communication about objectives and principles without creating quasi-commitments about future decisions. Markets, though, continue to treat every word from Warsh and his fellow committee members as critical to pricing the future path of interest rates, even if forward guidance is an art of the past.

Less guidance could mean more uncertainty

Despite Warsh’s efforts to avoid providing guidance, markets interpreted a hawkish signal. The front end of the Treasury curve moved first. The two-year yield rose about 7 basis points immediately after the speech, while the 10-year changed little and the 30-year eased. The flatter curve suggests investors increased the probability of near-term tightening while reducing long-term inflation concerns. The speech did not settle questions about Treasury buybacks, fiscal pressure, or the appropriate level of long-term yields. The interaction between monetary policy and debt management remains a risk to watch. Fundamentally, the market remains concerned about sovereign issuers’ fiscal sustainability.

Global businesses and investors face an additional layer of uncertainty from central bank divergence. Differences between the Fed, ECB, BOJ, and other policy paths can continue to drive material currency moves, while geopolitical developments and commodity prices can quickly change both inflation expectations and operating costs. This summer’s events around JPY weakening are just one recent example for investors to note. Similarly, gasoline and diesel prices in the U.S. are on a trajectory towards all-time highs because of continued inventory drawdowns due to the conflicts in Iran and Ukraine. With those factors in mind, Warsh specifically identified FX and commodity markets as signals the Fed will monitor.

AI reshapes the capital outlook

AI could change both sides of the economic equation. Warsh described it as a potential new factor of production. Investment in equipment and intangibles is rising around 9% year over year, with more than half of this year’s growth potentially tied to the AI buildout. Productivity gains could expand supply over time. The capital required to build leading models and infrastructure could also increase financing demand. While AI may indeed prove deflationary, we continue to see investments in AI and AI adjacent industries lead to increases in consumer prices throughout the economy.

Preparing for a wider range of outcomes

For businesses and investors, today’s market presents both risks and opportunities. Elevated rates can challenge valuations, refinancing economics, and project returns, while massive demand for AI, power energy, data centers, and related infrastructure could continue to compete for capital and create new investment prospects. That dynamic makes scenario planning, flexible financing, and active management of interest rate, FX, and commodity exposures increasingly important, while volatility itself may create opportunities for those positioned to act.

The picture will continue to evolve as geopolitical developments, inflation pressures, fiscal dynamics, and shifting capital flows reshape the outlook. I’ll join Jackie Bowie on September 17, the day after the FOMC meeting and the day of the BoE meeting, for Global Market Outlook: Rates, Risk, and the Changing Cost of Capital. We’ll explore the latest economic and policy developments, what they tell us about the path ahead, and what they could mean for rates, currencies, longer-term yields, and risk management.