Kevin Warsh’s quiet Fed in a face-off with Bessent’s Treasury

Kevin Warsh’s Jackson Hole speech signals a reluctance to promise policy, supports higher rates to tame inflation-raising dollar strength and pressure on emerging markets such as South Africa.

Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.

The annual Jackson Hole shindig for central bankers in the mountains of Wyoming has become a fixture in the monetary policy calendar. It is typically when Federal Reserve chairs step back from the monthly noise of economic data and explain how they think about monetary policy and the economy on a more philosophical level.

Some of these speeches have proven enormously consequential, changing the way investors see not just what will happen at the next interest rate meeting, but the direction of the Fed’s management of the economy itself.

Kevin Warsh’s first appearance as chair last Friday was less compelling. There was no new grand announcement on a shift of monetary direction.

But we did at least get some clarification regarding a fundamental issue which has clouded his first few months in the job: what does he think the Federal Reserve, the world’s most influential central bank, is actually there to do?

On this, he was rather clearer. His interpretation is not all that different from what previous holders of the position have understood.

Despite being torn between dual mandates, the Scylla and Charybdis of trying to achieve low inflation and full employment, his stance remains, after all, hawkish. He reiterated that the US is close to full employment while inflation remains stubbornly above the critical 2% target. That reality does not call for lax monetary policy.

The most important sentence in the speech was on this point. Warsh acknowledged that inflation data over the summer had been somewhat improved, but there was not enough data to suggest that the underlying reality of higher prices had changed meaningfully.

Markets reacted swiftly. Two-year Treasury yields jumped, as bonds sold off (yields move inversely to prices). Swaps markets moved to price in a greater-than-even probability of a rate hike in September. Investors are now having to deal with the reality that the most likely next move for US rates will be up.

In Pretoria at the Sarb, Lesetja Kganyago will not have missed the message.

A more hawkish Fed makes dollar assets relatively more attractive, supports the dollar and raises the hurdle rate for investors to consider investing in emerging-market assets such as SA. That can put pressure on the rand, push South African bond yields higher and reduce the room the South African Reserve Bank has to cut rates at home.

Elsewhere too, Warsh sounded hawkish. He rejected the idea doing the rounds in monetary policy debates that slowing real wage growth is a precursor to lower inflation. And he batted off the notion that strange labour dynamics in the US – where both hiring and firing have slowed due to the rise in immigrant deportations – have slowed markedly.

Putting all this together, Warsh’s reaction to data becomes easier to understand.