Inflation Data Released: Can Warsh Still Hold Steady?

Original title: PCE Inflation Data Sets High Bar for Warsh's Jackson Hole Speech
Original author: Jed Graham, Investor's Business Daily
Compiled by: BlockBeats

Editor's note: The U.S. July PCE inflation data released on Aug. 26 did not give the Federal Reserve much breathing room. Headline PCE rose 0.2% month-over-month and 3.7% year-over-year, while core PCE held at 3.3% year-over-year. Meanwhile, although second-quarter GDP growth was maintained at 1.5%, both consumption and private domestic demand were revised upward, indicating that underlying demand remains resilient.

This has shifted market attention further toward this Friday's Jackson Hole conference. According to the Federal Reserve's schedule, Fed Chair Kevin Warsh will deliver a keynote speech on Aug. 28. More critically, when the July FOMC maintained the federal funds rate range of 3.5%–3.75%, three committee members voted against it, advocating for a 25-basis-point rate hike.

Therefore, what this IBD article really discusses is not just a single PCE data point, but how Warsh will define the Fed's policy reaction function going forward: when inflation remains above target and demand has not clearly stalled, what exactly does the Fed need to see to continue holding steady, and what would prompt it to resume rate hikes.

This also determines the market significance of Friday's speech. If Warsh continues to emphasize inflation risks, the market may further strengthen pricing for a rate hike in September or even October; if he tries to downplay recent inflation, he will need to explain why current data is not yet sufficient to change the policy stance. More than a specific rate signal, the market needs to confirm from this speech how the Fed under Warsh's leadership intends to weigh growth, inflation, and financial conditions.

The following is a compiled translation of the original article:

The latest U.S. inflation data has not significantly eased the price pressures facing the Federal Reserve, and it has also raised the bar for Fed Chair Kevin Warsh's speech this Friday at Jackson Hole.

Data released by the Bureau of Economic Analysis (BEA) on Aug. 26 showed that the July PCE price index rose 0.2% month-over-month, higher than the market's expected 0.1%; the year-over-year increase remained at 3.7%, also above the 3.6% expectation.

Core PCE, excluding food and energy, rose 0.2% month-over-month and 3.3% year-over-year, roughly in line with market expectations. Personal income increased 0.4% month-over-month, above the expected 0.2%; personal consumption expenditures rose 0.2%, also exceeding the 0.1% expectation.

After the data release, IBD cited CME FedWatch data showing that the market's pricing for a Fed rate hike on Sept. 16 rose from 36% to 40%; the probability of at least one rate hike by the end of the Oct. 28 meeting rose from 50% to 55%.

PCE appears in line with expectations, but inflation has not truly eased

If one only looks at the rounded core PCE data, July inflation does not seem to have worsened significantly: core PCE remained at 0.2% month-over-month and 3.3% year-over-year.

But IBD points out that unrounded data shows July core PCE actually rose about 0.246% month-over-month, just a step away from rounding to 0.3%; the year-over-year increase was about 3.344%, at the relatively high end of the market forecast range.

However, the inflation details are not as hawkish as the headline numbers suggest.

The article notes that the Fed pays more attention to price categories that are directly market-priced. According to IBD's calculations, market-based core prices rose only about 0.15% month-over-month in July, and about 3.03% year-over-year. Some of the month's inflation came from non-market-priced items such as portfolio management fees, which are influenced by changes in asset prices like the S&P 500 index.

In other words, the July data is neither sufficient to prove that inflation is clearly re-accelerating, nor does it easily support the judgment that "price pressures have been brought under control."

For Warsh, this situation is even more challenging: inflation remains well above the Fed's 2% long-term target, but the data has not deteriorated to the point where immediate policy tightening is necessary.

GDP is only 1.5%, but underlying demand is stronger than the headline

At the same time, U.S. economic growth data has not given the Fed a clear signal that "the economy is clearly cooling."

The BEA's second estimate of second-quarter GDP showed that U.S. real GDP grew at an annualized rate of 1.5%, unchanged from the initial estimate and a slowdown from the first quarter's 2.1% growth.

But beneath the headline GDP figure, private demand was revised upward.

Second-quarter consumer spending growth was revised up to 3.4%. The "real final sales to private domestic purchasers," which better reflects the endogenous demand of the U.S. private sector, was revised up from an initial annualized rate of 3.9% to 4.2%. This indicator is mainly composed of consumption and private fixed investment, and is relatively less affected by fluctuations in inventories, trade, and government spending.

This presents a somewhat contradictory combination for the second-quarter economy: overall GDP growth is not fast, but private demand is not weak.

July durable goods orders also showed a similar pattern. According to IBD's summary, durable goods orders rose 1.1% month-over-month, higher than the market's expected 0.5%; however, core capital goods orders excluding defense and aircraft rose only 0.2%, below the 0.9% expectation. Meanwhile, June core capital goods orders were significantly revised up to 1.7%.

Therefore, this set of data is difficult to simply categorize as "economic overheating" or "rapid economic cooling." More accurately, U.S. demand remains resilient enough that it is difficult for the Fed to shift to a more accommodative policy stance based solely on slowing growth.

Three dissenting votes mean Warsh faces more than just the market

More important than the PCE data itself is the widening divergence within the Federal Reserve.

At the July 28–29 FOMC meeting, the Fed decided by a vote of 9 in favor and 3 against to maintain the federal funds rate target range at 3.5%–3.75%. The three who opposed keeping rates unchanged—Cleveland Fed President Beth Hammack, Minneapolis Fed President Neel Kashkari, and Dallas Fed President Lorie Logan—all advocated for a 25-basis-point rate hike.

This means that Warsh needs to influence not only financial markets on Friday. If he wants to maintain the current rate level, he must face voices within the FOMC that have openly called for further tightening; if he clearly leans hawkish, it could further push up market expectations for a September rate hike and affect long-term Treasury yields and financial conditions.

IBD also specifically mentioned that after the late-July FOMC press conference, U.S. long-term Treasury yields rose noticeably for a time, bringing Warsh's influence on financial markets into observation.

This makes the Jackson Hole speech an important test of the policy reaction function. Simply put, the policy reaction function is what the market tries to determine: when inflation, employment, growth, and financial conditions change in certain ways, what policy actions will the Fed take.

What the market really needs to find from Warsh's speech is not necessarily a clear answer like "whether to raise rates in September," but which variables he intends to give higher weight to.

What to really listen for on Friday: how Warsh defines "conditions for not raising rates"

The current macro combination does not give Warsh an easy policy choice.

Inflation remains well above the 2% target, private demand remains resilient, and three FOMC members have already called for rate hikes; but on the other hand, core inflation has not clearly spiraled out of control, and overall economic growth has slowed to 1.5%.

Therefore, there are three directions worth watching in Friday's speech.

First, how Warsh describes current inflation. If he emphasizes core inflation above 3% and the persistence of price pressures, the market may further increase the probability of rate hikes at upcoming meetings; if he places more emphasis on the slowdown in market-based core prices, it would suggest a relatively moderate interpretation of recent PCE data.

Second, how he assesses economic demand. With second-quarter GDP at only 1.5% and private domestic demand growing at 4.2%, which number Warsh chooses to emphasize will directly affect the market's understanding of the Fed's growth assessment.

Finally, and most critically, whether he further clarifies the Fed's policy thresholds—under what circumstances the current rate is sufficiently restrictive, and under what circumstances inflation would force the Fed to resume rate hikes.

The Fed's next policy meeting will be held on Sept. 15–16, and will include updated economic projections. Before then, changes in employment, inflation, and financial conditions could still adjust market expectations.

Therefore, the core question at Jackson Hole may not be whether Warsh will directly signal a September rate hike, but whether the market can discern from his speech something more important: with inflation still high and the economy not clearly stalling, under what conditions is the Fed under Warsh's leadership prepared to act.

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