At first glance, the FOMC’s 9-3 split decision was exactly in line with the expectations we outlined in our report. Fed Announcement – Divided HoldJuly 22. We also named three dissidents – Hammack, Logan and Kashkari – as hawks most likely to support a quick tightening of monetary policy. However, the most critical part of the forward for markets was that Chairman Warsh himself voted for the unchanged decision despite his hawkish commitment to price stability that he had heard in June.
Warsh emphasized several times that real interest rates rose over the intersession because markets were taking cues from data rather than forward forecasts. We do not share this view as the data released at the end of June was close to expectations and instead believe that markets were reacting to Warsh’s words about “regime change”. And in this lightweight tonight the reaction gave the impression that markets were reconsidering their faith in the chairman’s ability to keep his price stability promise.
Markets lowered expectations of interest rate increases, and the cumulative prices of increases dropped from 56 bp to 50 bp. The implied rate for a September hike dropped from almost certain to 65%. More importantly, however, the UST yield curve saw its sharpest steepening since behind schedule March at 2.10s as inflation expectations rose from the long end. The current level (10-year inflation swap at just above 2.3%) is by no means alarming per se, but if Warsh was cheerful with the market reaction after June, today’s change probably wasn’t what he expected.
We continue to believe that the macroeconomic case for a subsequent tightening of monetary policy remains powerful. Artificial intelligence investment spending, tightening labor market balances, high consumer willingness to spend and supportive fiscal policy all raise the risk of persistent inflation. And if financial conditions deteriorate further, Warsh may be forced to reconsider his vote as early as September.
We maintain our base scenario assuming interest rate increases by 25 bp at the December and March meetings.. It’s critical to note that the Fed hasn’t made any changes to its balance sheet policy, and Warsh made no mention of changes ahead of the task force results, which are expected later in the year. The Federal Reserve of New York is recommending $10 billion a month in reserve management purchases of Treasury bills.
