Raphael Olsyzna-Marzys, international economist at J. Safra Sarasin Sustainable Asset Management, reflects on this week’s developments in the US following new Fed Chair Warsh’s first FOMC meeting, as he shares his thinking on what it means for the US economy and the markets in the weeks and months ahead.
The Fed has pivoted decisively towards hawkishness. Although an upward revision to the “dots” was anticipated, the scale of the shift surprised markets. More striking was Kevin Warsh’s alignment with the hawks, despite his rejection of forward guidance – a tool now relegated to history. Alongside this, the new chair intends a sweeping institutional overhaul to improve its credibility. Yet such reforms are unlikely to substitute for higher rates should inflation prove sticky and the labour market remain robust.
Not leaning against hawkish guidance
If President Donald Trump thought he had appointed a dove as Fed chair, the bond market’s reaction on Wednesday will have come as a surprise. The reason for the repricing was clear. While rates were left unchanged, nine of the 18 policymakers submitted rate projections implying at least one increase by year-end, with five pencilling in two hikes and one projecting three. The median dot now points to one increase this year, followed by a cut next year and another in 2028. As expected, Kevin Warsh did not submit his own projections, another sign that he has little faith in forward guidance. That scepticism was also evident in the unusually short statement, which largely confined itself to the facts. Any guidance was removed, but the committee’s commitment to price stability was stressed. The rest of the projections changed broadly as we anticipated in our preview, with higher inflation, slightly weaker growth and lower unemployment.
Before the meeting, an important question for us was whether Mr Warsh would prove collegial and how hard he would push his belief that AI will be disinflationary. On the first count, he did. On the second, he did not. Instead, he assigned the issue to a task force. The unanimous support of all 12 voting members suggests that he has succeeded in building consensus. During the press conference, he spoke for the committee rather than for himself – a committee that has become noticeably more hawkish. He repeatedly stressed that the Fed had failed to deliver price stability over the past five years and that he in-tended to change that. Markets took him at his word, with real rates moving higher and the curve flattening.
Warsh wants to improve Fed credibility
Will restoring price stability require higher rates? Perhaps, perhaps not (no forward guidance, please). He appears to believe that greater credibility could substitute, at least in part, for additional tightening. We are not convinced that the Fed has a credibility problem to start with. Market-based measures of inflation expectations remain well anchored. Still, he seems to think that credibility can be strengthened by overhauling the institution itself.
To that end, he announced five taskforces covering: communication; the balance sheet and operating framework; alternative data sources; productivity, jobs and AI; and the inflation framework. Their recommendations may not arrive until the end of the year, making this more a declaration of intent than a blueprint for immediate change. It also preserves Mr Warsh’s optionality. One thing, however, was clear: he has no intention of moving the goalposts. The inflation target remains 2%.
Institutional reform not a substitute for higher rates
We are sceptical that institutional reform can substitute for higher rates. Most evidence suggests that AI is currently boosting demand more than supply. Mr Warsh also argued that monetary policy does not appear especially restrictive outside the housing market. That lowers the bar for further tightening.
Another notable feature of the meeting was the Fed’s desire to say less. The new Chair argued that reduced guidance would force markets to form their own views about the ap-propriate policy rate, improving price discovery. That may be true. But it is also likely to increase volatility in both bond and equity markets and widen the range of possible policy outcomes between meetings.
Higher likelihood for higher rates
The likelihood of tighter policy is rising, which was also reflected in Fed officials’ shifting assessment of risks to their dual mandate. We also doubt that if there were a rate hike this year, it would be reversed next year, as implied by the new dot plot. A stronger labour market and persistently high core inflation are more likely to require further tightening. AI appears to be changing tasks, job descriptions and per-haps the relative demand for labour, but evidence so far suggests it has neither reduced aggregate employment nor raised unemployment. That may change over time. In the near term, however, we do not think these developments are significant enough to alter the Fed’s reaction function.
