It’s Fed day with the decision to be released at 2 pm ET and the press conference with Chairman Kevin Warsh starting 30 minutes later.
This has the potential to be one that lands in the textbooks. It’s the first real test of Warsh’s political courage and independence. At Jackson Hole in August, he took a surprisingly hawkish line and that’s led the market to price in a 91% chance of a rate hike, with 90 bps priced in for the year ahead. Those numbers rose in the past few weeks as US economic data beat expectations and inflation numbers were slightly higher than expected. Today, that sentiment was compounded by a retail sales report showing the closely-watched control group of core sales up 1.4% compared to 0.4% expected.
With all that, markets and economists have overwhelmingly concluded that he will hike rates.
The x-factor –as it always is — is Trump. The US President is an extreme dove and believes rates should be cut, and he hand-picked Kevin Warsh and several Fed Board members to further that goal. Warsh played up that angle during confirmation but since he’s assumed the leadership, he’s taken a different line, criticizing past versions of the Fed and saying they will get inflation to 2%.
The thing is, talk is cheap. Trump attempted to criminally investigate Fed Chairman Powell in a political vendetta because he wouldn’t do as the President wanted. Now Warsh is tasked with defying him at a critical time before the midterms, when Republicans are behind in the polls and in danger of losing both the House and the Senate.
Polymarket is taking bets that Trump will publicly insult Warsh by Sept 30 and it’s trading at 47%.
So whatever happens today, we are likely to get either central bank drama or political drama.
For markets, political drama is nothing new. Warsh is likely insulated on the political side because is father in law is Ronald Lauder, a major Trump supporter and donor and friend. Of course, with Trump you never know and I wouldn’t expect a smooth ride for Warsh if he follows what’s currently priced into the market.
The thing is, Trump mostly has himself to blame for rate hikes, as I strongly suspect the Fed would be waiting if not for the energy price spike due to the Iran war.
In terms of markets, a rate hike today isn’t going to create a major ripple in markets but what could is commentary afterwards. I would expect another non-commital statement but in the press conference, Warsh will be pressed on what comes next. He is likely to fall back on his preference not to pre-commit it won’t be easy. He’s cast himself in a hawkish light in Jackson Hole and will have to repeat some of those messages to avoid sounding dovish. However by repeating them, he also risks sounding overly hawkish and pushing up the odds of a second hike in October.
His key message at Jackson Hole:
The thing about market measures of inflation expectations in economic history is that they tend to look strong and durable until they don’t. Those expectations are not pushed around easily, and right now they are well anchored. But they must be closely minded. It’s the Fed’s job to make sure that inflation expectations do not get unanchored.
There is one signal nobody can miss: The responsibility for 65 months of sustained, elevated inflation sits squarely with the central bank. And that is where it belongs.
Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job . . . our mandate . . . and our charge to keep.
So what if Warsh defies the market and doesn’t hike rates?
That would likely be a seminal moment in central banking. The Fed is one of the few insitutions left in the United States with independent credibility. The commitment to 2% inflation hasn’t been met lately, but there is still a strong belief that officials are doing their best. If they don’t hike today, there is a big risk of losing the long end of the bond curve and unmooring inflation expectations.
US 10-year yields this week rose to 5.04%, the highest since 2007. The fiscal picture is out of control and if monetary policy is viewed to be politically compromised, then the US dollar is as well. I would expected massive bids in gold on a rate hold and that would be the first trade I would expect most traders to make. The dollar would slide but there’s the risk of a negative feedback loop with bonds that creates a flight to USD safety in the short term, particularly against EM currencies and commodity currencies.
I would much rather we don’t go down that road, but if you’re a trader, today is a good day to be ready for anything.
This article was written by Adam Button at investinglive.com.