Kevin Warsh may hike next week to please traders not the core print

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Core inflation is 2.4% and long run expectations remain around the mid 2s, yet the 10 year is near 5%, which tells you this is increasingly about real yields, term premium, Treasury supply and expectations for future growth and policy.

That can persist for a while, but if high energy costs and restrictive rates start crushing consumption, hiring, profits and credit across the U.S., Europe, Asia and emerging markets, the growth outlook can change quickly. The U.S. will not be immune. Hiring weakens, unemployment rises, earnings come under pressure and credit stress builds.

Historically, the 10 year often starts falling before the Fed actually cuts because bond markets price the slowdown in advance, as they did ahead of the 2001 and 2007 easing cycles. Once markets become convinced the deterioration is durable, they begin pricing weaker nominal growth and future Fed easing, which is when real yields and the long end can finally roll over.

A Major Wall Street Firm’s Fed Call Is About Wall Street, Not Inflation

A major Wall Street firm shifted from forecasting a September hold to a 25 basis point hike, not because the inflation data materially changed its view, but because markets had moved to price nearly a 90% chance of a hike and the FOMC might want to avoid disappointing them.

No material change in its inflation outlook.

The firm said August CPI lifted its core PCE forecast only marginally, to 0.26% month over month.

That is the Wall Street wall of mirrors:
No material change in inflation outlook, but a hike to calm Wall Street.

The August data do not establish entrenched inflation. Headline CPI was driven by an energy shock, gasoline rose 3.9% and energy 2.1%. Rate hikes cannot produce oil, expand refining capacity, or repair disrupted supply routes. They reduce demand, investment, employment, and household purchasing power.

Core CPI rose 0.3% in August, but annual core inflation fell to 2.4%, its lowest reading since March 2021. The monthly increase was influenced by a 5.9% jump in wireless services. Wage growth slowed to 3.1% year over year, while real hourly earnings fell 0.1% in August. There is no demonstrated wage price spiral, no verified second round inflation, and no evidence that the energy shock is becoming embedded.

If the Warsh Fed hikes simply to validate Wall Street’s futures market narrative, Warsh’s critique of the Wall of Mirrors and his promise to end forward guidance will not have been worth the paper his Jackson Hole speech was written on.

The real credibility risk is not disappointing traders, it is showing that Wall Street expectations still dictate policy rather than data and sound monetary theory.

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