Here’s my contrarian thought going into tomorrow.
Warsh can hike rates without actually hiking rates.
He may have already done it.
At Jackson Hole, Warsh said the Fed still had “work to do” if inflation wasn’t moving toward 2% clearly and quickly enough.
The bond market listened.
September hike odds jumped from roughly 35% to around 60% immediately after the speech, and the policy-sensitive 2-year Treasury yield jumped with them. Since then, the 10-year has pushed toward 5%.
That matters because the Fed Funds Rate isn’t the only thing that tightens the economy.
Higher Treasury yields → higher borrowing costs → tighter financial conditions.
Warsh talked like a hawk, the bond market repriced the entire rate path, and a significant amount of tightening happened without the Fed touching the policy rate.
So why does he need to hike Wednesday?
There’s also a Treasury problem here.
The U.S. is already dealing with extremely high long-end borrowing costs. Adding another Fed hike risks putting even more pressure on financing conditions at exactly the wrong moment.
And here’s the paradox.
Even holding could potentially tighten financial conditions.
If Warsh holds and the bond market interprets it as the Fed being unwilling, or politically unable to fight inflation, investors could demand a larger term premium to own long-duration Treasuries.
Long yields could rise.
In that scenario, Warsh holds the Fed Funds Rate steady and the bond market hikes for him anyway.
That’s why I think Wednesday is much more complicated than:
“Inflation is high → Fed must hike.”
Warsh has already established his hawkish credibility.
Markets have already tightened.
Treasury yields are already around levels we haven’t seen since 2007.
The Fed doesn’t necessarily need another 25 bps to tighten financial conditions.
Warsh may have discovered the most powerful hike available to him is the one he doesn’t actually have to make.