The Federal Reserve maintained its policy rate between 3.5% and 3.75% on Wednesday as three members of the Federal Open Market Committee dissented from the majority in what amounts to a raucous status quo at the central bank.
The three dissents in the 9-3 vote, though, came from regional presidents— Neel Kashkari, Lorie Logan and Beth Hammack—and not from the Board of Governors.
Once dissents start to come from the Board of Governors, the family fight that Fed Chair Kevin Warsh has said is a good thing will spill over into financial markets, disturbing retirement accounts held by the public.
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The Fed made no changes to its policy statement as the central bank moves along lines that will continue to inject uncertainty and volatility into financial markets.
Parsimony, uncertainty and volatility are the points put forward by Warsh as he attempts to change the Fed’ s policy regime. But the sparse statements put forward early in his tenure will not be well received by the public outside a small section of institutional investors.
In his news conference after the meeting, Warsh sounded a hawkish note around the policy objective of returning inflation to 2%.
His explicit notation of rising real yields will reinforce market expectations around a potential rate hike in September, which would support Warsh’s attempt to establish his credibility early in his tenure.
We agree with that policy objective as Warsh chooses not to tell us anything new or surprise those of us who have read his public statements over the past three decades.
One gets the sense that the objects of Warsh’s attention are those who have made the case that the Fed’s 2% inflation target is outdated.
Perhaps he will address those people at the Fed’s economic policy symposium in Jackson Hole, Wyo., next month. It would be of interest to investors to hear from Warsh on why the 2% target should be retained and reinforced.
Simply talking about price volatility and different inflation numbers is a necessary but not sufficient condition to obtain the confidence of market participants.
The real question is what the Fed’s reaction function is and how the central bank will accomplish Warsh’s objective.
Uncertainty and volatility are a feature and not a bug of that framework.
Looking ahead
We do not anticipate that the Fed will change its policy rate for the remainder of the year even though inflation is running closer to or above 3% after more than five years of running well above the central bank’s 2% target.
The nature of the supply shock and the Fed’s tendency to look through such shocks implies that the Fed has the space to keep the policy rate on hold.
But the risk of a near-term rate hike is rising as a growing faction of Fed members are agitating for such a policy move.
This is why three regional presidents dissented, why a growing faction is making a case for rate hikes and why in the runup to this week’s meeting investors have priced in a growing probability of a rate hike in September.
One gets the sense that at least some members of the Fed are itching to take back last year’s insurance rate cuts that were imposed as hiring slowed.
Now that we have a better sense of what full employment means as hiring has improved, higher rates are a risk as the Fed’s family fight spills into public view.
To be clear, enhanced volatility in oil and energy prices will be part of the economic and policy landscape for the near future as geopolitical tensions continue.
Warsh and the Fed will need to lean into the wind here and explain their approach on forward guidance.
Perhaps Warsh, as he hinted on Wednesday, will use his Jackson Hole speech next month to articulate his reaction function around what he thinks is the optimal policy rate and all that entails. But for now, all we have to go on is the Fed’s limited rhetoric.
Of course, the elephant in the room is that the hawkish tone of the Fed chair is at odds with the preference of the White House for a rate cut.
On to Jackson Hole and a discussion around the efficacy of Fed policy, the central bank’s preferred inflation metrics and a further elucidation of Warsh’s reaction function.
‘This has turned out to be anything but a boring and uneventful summer.
