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Fed Chairman Warsh's credibility shaken after his rate decision
Economy
For Kevin Warsh, who values his reputation above all else as Fed Chairman, the market reaction to his speech on Wednesday must have been painful, CNBC reports.
Warsh held a press conference following the FOMC meeting, which voted 9-3 to keep rates unchanged. This was only the second such meeting since he took over as Fed Chairman on May 22. Investors sharply reduced the likelihood of a rate hike at the next meeting, but pushed up long-term Treasury yields.
After the press conference, 30-year Treasury yields reached their highest since 2007, while 2-year yields declined. The probability of rates remaining unchanged at the next meeting jumped 20% to 45%, according to CME FedWatch. This suggests that investors aren't expecting an immediate Fed response to inflation, which Warsh himself has said has exceeded its 2% target for at least 63 months.
Before taking office, Warsh sharply criticized his predecessor, Jerome Powell, citing a lack of credibility as the root problem. Warsh needed to clearly explain what would ultimately force him to raise rates in the face of persistent inflation, wrote longtime Fed observer John Hilsenrath.
"Warsh failed to convey that message clearly, and the bond market reacted painfully," he said.
Warsh changed Fed policy, abandoning the practice of forward guidance, believing it made the Fed inflexible.
"We need to watch the market's reaction to events—direct and unfiltered," he said.
The press conference puzzled economists.
"It was confusing and often self-contradictory," wrote Eric Winograd of AllianceBernstein.
Consumer price index data showed a 0.4% decline in June, but Warsh said this factor was "not particularly" taken into account, confirming that inflation is still "elevated." The Fed is officially committed to a 2% target for the personal consumption expenditures (PCE) index, which was last measured at 4.1%. Warsh added that one of the working groups he created may propose reducing the role of PCE as a target.
"For now, we're sticking with PCE. But who knows what we'll say about strategy after next January," he said.
"Both of these issues raise questions about the new chair's credibility on inflation reduction," wrote Michael Feroli, chief U.S. economist at JPMorgan Chase.
The Fed chair doesn't set rates alone—he's one of twelve votes on the FOMC. Three voted against the decision on Wednesday, and if the data doesn't improve, others could join them.
"This will add urgency to the rest of the committee to act," Feroli wrote.
A Fed chair has never found himself in the minority on a rate vote.
This puts Warsh in a difficult position: his reputation could be damaged both in the eyes of the market and within the Fed within just a few months of taking office.