Warsh’s focus on price stability does not point to rate hikes

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Federal Reserve Chair Kevin Warsh said he will stick to the US central bank’s 2% inflation target and “disappoint” anyone who expects otherwise. Speaking at the European Central Bank’s annual forum on Wednesday, Warsh reiterated the Fed’s commitment to delivering price stability. The yield on 10-year US Treasuries rose 5 basis points to 4.47%.

But Warsh also said that inflation risks have come down in recent weeks, with inflation expectations moving lower. He gave little indication about where he thinks monetary policy or the economy are headed, pushing back on efforts to extract forward guidance.

Markets continue to price in around two 25-basis-point rate increases over the next 12 months, as investors look to June’s employment report on Thursday for more clues on the Fed’s interest rate path. We maintain the view that current market conviction around Fed rate hikes is too aggressive.

The resilience in the US jobs market is not driving price pressures. Ahead of the official count on job growth, ADP data showed solid US private-sector job creation in June, with company payrolls rising by 98,000. This marks the best three-month stretch for hiring in more than a year. But while recent headline data point to resilience in the US labor market, wage dynamics continue to move in a favorable direction from an inflation perspective. Average hourly earnings growth has continued to decelerate, reinforcing the view that wage-driven inflation pressures are no longer a primary concern. The risk of larger-than-expected labor market displacement from AI may also shift the Fed’s focus toward downside risks to employment.

Inflation should moderate as the year progresses. While AI-driven demand remains a source of inflation risk, recent data showed that tariff effects are increasingly shifting onto a disinflationary path for the second half of this year. Our analysis suggests that the unwinding of the tariff pass-through effect could reduce inflation trends by 0.8 percentage points over the next year. Additionally, oil prices have returned to levels prevailing before the US-Iran conflict, and while the peace talks may be bumpy, a gradual resumption of traffic through the Strait of Hormuz should help with supply bottlenecks and ease inflation concerns.

The Fed’s new task forces could delay policy adjustments. While Warsh offered little guidance on the Fed’s interest rate path, he said that some of the key appointments to the five task forces reviewing Fed operations will be named next week, hinting that foreign central bankers may be named to some of the panels. He added that it was his “aspiration” that within a year, the US central bank will shift to using real-time data to set monetary policy and would rely less on backward-looking government surveys. As the Fed reassesses its framework and tools, we expect the review process undertaken by the task forces to delay major policy adjustments in the near term.

So, we believe the Fed will keep rates steady in the near term and see scope for markets to scale back their expectations for Fed tightening. This should benefit short- to medium-maturity quality bonds as yields fall, and we see current elevated yields as an opportunity for investors to lock in durable portfolio income.