Early in Kevin M. Warsh’s second news conference as chairman of the Federal Reserve, he laid out how the central bank would ultimately be assessed as it takes on one its most challenging inflation problems in decades.
The central bank was in the business of “performance,” he told reporters on Wednesday, after the Fed’s decision to hold rates steady at a range of 3.5 to 3.75 percent. “We are going to be judged by how we perform.”
Financial markets swiftly rejected Mr. Warsh’s approach, which involved tough talk on inflation but stopped well short of embracing the prospects of higher rates to quell price pressures. The response, primarily from the $28 trillion U.S. government bond market, was unequivocal. Markets expected more from a policymaker who has made taming inflation a top priority of his chairmanship.
Long-term government borrowing costs shot higher as Mr. Warsh spoke, with the 30-year bond notching its largest one-day increase in more than a year. Trading around 5.22 percent, it is at the highest level since 2007. The 10-year Treasury yield, which serves as the benchmark for borrowing costs around the world, also rose alongside expectations about inflation over a longer time horizon. Stock markets sold off, too, even as investors pushed back the timing of potential rate increases until later this year.
“The markets initially interpreted the price stability tough talk as someone who was willing to take the necessary action to address inflation and then was surprised that there wasn’t follow through,” said Lael Brainard, who served as vice chair at the Fed until she left to become the top economic adviser in the Biden administration in 2023.
Mark Cabana, an interest rate strategist at Bank of America, added: “As a central banker, this is exactly what you don’t want. You don’t want the market questioning your inflation credibility.”
The chance of some kind of disappointment was elevated going into the July meeting in large part because there was a vocal contingency of investors who were making the case for Mr. Warsh to deliver a surprise quarter-point increase. The odds of such a move were around 30 percent ahead of Wednesday’s announcement. Three presidents from the regional banks thought that it was also the optimal decision and dissented against leaving rates unchanged.
The rationale for a rate increase was that an aggressive move early in Mr. Warsh’s tenure as chairman would help to cement his reputation as the inflation fighter that he strives to be.
Mr. Warsh tried to maintain that image on Wednesday. In his opening statement at the news conference, he said that “where necessary and appropriate, we will not hesitate to act” to squash inflation. He made clear that the Fed would, at least for the time being, not accept anything above 2 percent inflation, as measured by the Personal Consumption Expenditures price index. He also repeatedly stressed that there was “nothing inertial” about the Fed’s discussions or strategy even as it stood pat. Moreover, he pushed back on the framing that July’s meeting represented a “pause.”
But those “elements of hawkishness” — as Tiffany Wilding, an economist at PIMCO, the asset manager, described it — were overshadowed by Mr. Warsh’s unwillingness to lay out the conditions under which he would consider raising rates. In fact, he only briefly acknowledged that higher borrowing costs were a tool at the Fed’s disposal to address inflation. Mr. Warsh also did not give any indication of how he saw the data evolving in coming months, nor did he make any specific mention of the Fed’s next meeting in September as a potential platform to take action. In summation, he described the current moment as “a period of watchful thinking, not watchful waiting.”
“No forward guidance. No framework guidance. No nothing,” said Ms. Wilding. That, coupled with Mr. Warsh’s repeated mention that the Fed would focus on a wide range of inflationary measures, gave her the impression that the timing of any rate increase was highly uncertain.
What was missing was the point emphasized in the minutes from Mr. Warsh’s first meeting in June, which stipulated that if inflation stayed stubbornly high, most officials believed that “some policy firming” was warranted. Several policymakers built on that communiqué and stressed that they needed to see a deceleration in inflation soon.
That omission was likely a strategic one from Mr. Warsh, who has rejected the Fed’s longstanding practice of sending cues to markets on what the central bank will do and how it may react to incoming data. His view is that the Fed benefits from a “direct and unfiltered” signal from markets about what the central bank should do, rather than having officials’ signals reflected back.
On Wednesday, Mr. Warsh repeatedly referenced the recent tightening in financial conditions, which capture the availability of credit across the economy, as having given policymakers “some comfort that we’ve got the ability and capability to deliver.”
Kurt Lewis, who served as a senior adviser to Jerome H. Powell, the former Fed chair, likened Mr. Warsh’s strategy to “trying to convey the same message that was conveyed in the minutes with both hands tied behind his back because of that rhetorical choice.”
Mr. Lewis reckoned that “whether by force or choice, he will change how he approaches the news conference in the future, just because it will be easier for him to communicate if he does so more directly.”
Mr. Warsh’s ability to avoid another credibility test by markets will depend on if the economic data cooperate and keep a rate increase at bay, said Avisha Thakkar, head of Macro & Fixed Income Research at Schonfeld, a hedge fund.
“The view in the marketplace is that by September, if they don’t deliver it and inflation proves stickier, then he will have ‘failed’ that test,” she said.
For Ms. Brainard, the risks are pointing in essentially one direction, meaning Mr. Warsh will remain under trial in the coming months.
“I think inflationary pressures are set to continue at an elevated level through the end of the year, which means that the case for a hike before the end of the year has certainly gotten stronger,” she said.
