Key Takeaways:
Warsh's hawkish Jackson Hole debut reset market pricing for a September rate hike to nearly 60 percent, offsetting the Treasury's bond-buyback intervention and pointing to higher funding costs.
Federal Reserve Chairman Kevin Warsh's hawkish Jackson Hole debut pushed market pricing for a September rate hike to nearly 60 percent, offsetting the Treasury's bond-buyback intervention and pointing to higher funding costs across markets.
"The U.S. bond market is not facing a crisis yet, but we do expect higher funding costs," said Eric Robertsen, global head of research and chief strategist at Standard Chartered.
Warsh's Aug. 28 speech, delivered on his 100th day as chairman, reset expectations in the CME FedWatch tool for a 25-basis-point hike to nearly 60 percent from 35 percent the prior day. The Fed's preferred inflation gauge, the 12-month change in the PCE price index, stands at 3.7 percent while the six-month change is 4.1 percent, both above the 2 percent target. Gold fell about 1 percent during the speech, and the 10-year Treasury yield has settled between 4.50 percent and 5 percent.
With the Federal Open Market Committee holding the fed funds rate at 3.5 percent to 3.75 percent since July's 9-3 vote, the Sept. 16-17 meeting now hinges on the August employment and CPI reports. If inflation fails to cool, Robertsen expects Asian currencies to underperform their emerging-market peers as funding costs rise.
Warsh's tone marked a departure from the "word salad" investors said they heard after the July policy meeting. "We have work to do," he said of taming elevated inflation, while cautioning against the "hall of mirrors" problem of markets relying on Fed guidance for trading decisions. He also said he would be "hard pressed to describe broad financial conditions as restrictive," noting that credit and loan activity show little evidence of restraint.
The hawkish messaging offset the Treasury's announcement that it would double its buybacks of long-end securities, a program some investors read as an attempt to cap long-term yields. "If the buyback plan is there to bully long-end yields lower on a structural basis, there is a war to be fought ahead," ING said.
The last time the Fed signaled a willingness to raise rates after a prolonged hold was in 2022, when a 25-basis-point hike in March preceded a 10 percent slide in the S&P 500 over the following quarter. This time the reaction has been more contained, with the VIX volatility index easing about 1 percent during the speech.
For Asian currencies, the transmission runs through the dollar. "Uncertainty over the Fed's reaction function and concerns that policymakers may be placing less emphasis on inflation control have increased market focus on Warsh's comments," OCBC Group Research said. "The USD could find support if Warsh and other Fed officials push back against currency debasement concerns and reaffirm their commitment to returning inflation to the 2 percent target."
Robertsen's view that Asian FX will underperform its emerging-market peers reflects the region's heavier reliance on imported energy and its sensitivity to higher U.S. funding costs. A hawkish Fed that lifts the dollar would pressure currencies from the yen to the won, while commodity-linked emerging-market currencies could find support from elevated gold and oil prices.
The September decision remains a close call. Morgan Stanley chief U.S. economist Michael Gapen said the result should be enough to keep the Fed on the sideline next month, while Nomura Asset Management's Greg Gizzi expects the committee to hold steady. "The hawkish messaging was unmistakable," Gizzi said, though he noted Warsh stressed that medium-term inflation expectations "are well anchored."
This article is for informational purposes only and does not constitute investment advice.
