Warsh’s Hawkish Background And The Federal Reserve’s Policy Orientation – Analysis
By Wei Hongxu
Key Takeaways:
- ANBOUND’s Wei Hongxu says new Fed Chair Kevin Warsh used Jackson Hole to sound hawkish: unless core inflation is clearly heading back to 2%, the Fed has “more work to do,” including room to hike. Markets briefly priced a September hike near 60% and extra tightening into early 2027.
- Warsh is framed as defending Fed independence and wanting less forward guidance (more Greenspan-style vagueness), plus principles that stress data, the 2% PCE target, conventional rate tools, and smaller balance sheets—not acting as Trump’s rate-cut agent.
- The author doubts quick results: sticky services and rent inflation, huge U.S. debt that makes QT and hikes fiscally painful, and possible deregulation that could expand broad money even if the Fed shrinks its own book. Treasury yields staying high are read as skepticism that the 2% goal will be met soon.
Since Kevin Warsh assumed office as Federal Reserve Chair, although he has emphasized Fed reform, markets have consistently focused on his monetary policy orientation and the direction of systemic reform. However, given Warsh’s adjustment to his communication with the market, outsiders still cannot discern his true policy stance. This also made the recently held Jackson Hole Economic Policy Symposium a rare window for observing the direction of the Federal Reserve.
At the symposium, Warsh delivered a speech titled “In Our Time”, explaining his latest governance philosophy and medium-to-long-term reform direction for the Fed. This is also the first time Warsh has systematically articulated his policy stance since taking office as Fed Chair, holding significant directional implications for the future course of global monetary policy and asset pricing. At the symposium, Warsh signaled a clear hawkish stance, stating that if it cannot be confirmed that core inflation is returning toward the 2% target at a clear and steady pace, the Fed has “more work to do”, and he will retain the policy space for interest rate hikes.
This statement effectively provided a clear direction for the trajectory of the Fed’s monetary policy. According to media reports, following Warsh’s speech, the market probability of a rate hike in September surged from the previous 35% to about 60% at one point. Meanwhile, Bloomberg data showed that traders are not only preparing anew for a 25-basis-point rate increase within the year, but are also beginning to lean toward betting on the possibility of two rate hikes by March 2027. This means that although Warsh has not yet explicitly expressed the intention to “raise interest rates,” given the current reality that inflation remains significantly higher than the 2% target, the market already expects the Fed to be compelled to restart rate hikes after observing for several months.
The significance of Warsh’s “hawkish” stance lies in the fact that it inherits his pre-assumed attitude of upholding the independence of the Fed. Previously, Trump constantly intended to influence former Fed Chair Jerome Powell to cut interest rates through various means, which was understood by outsiders as an erosion of the Fed’s independence. Meanwhile, the appointment of Warsh, who has close ties to Trump, was speculated to accommodate Trump’s demands for loose monetary policy. After months of standing pat, Warsh’s stated commitment to the inflation target this time distanced him from Trump’s position. Bloomberg even claimed that his “hawkishness” is more intense than during Powell’s tenure, the period that was heavily criticized by Trump. As it stands, Trump, who has recently been preoccupied by the ongoing U.S.-Iran conflict, once again demands rate cuts, adding obstacles to monetary policy decision-making under Warsh’s leadership. However, Warsh’s hawkishness exists in a different external environment from Powell’s. Trump, troubled by inflation, needs to consider his political legacy after his term ends. After all, Trump’s remaining term is just a little over two years, whereas Warsh needs to prepare for the “post-Trump era”. What Warsh likely needs to prioritize is not catering to Trump, but considering how to cooperate with the future administration in the post-Trump period.
During this conference, Warsh touched once again upon the issue of “forward guidance”. He believes that this tool is no longer suited to a normalized economic environment. Instead, it severely restricts the flexible adjustment space of monetary policy and creates a vicious cycle of intertwined “hall-of-mirrors” problems. This means Warsh may wish to return to the vague expressions of the Greenspan era to preserve policy flexibility, rather than the clear guidance of subsequent chairs. However, Warsh has not yet put forward a vision for a new, effective communication mechanism. The market, too, needs to grope its way anew regarding how Warsh releases information and guides market expectations. This implies rising communication costs and uncertainty facing the Fed’s policy orientation. Although Warsh’s “hawkish” attitude has manifested quite prominently, the market may only fully comprehend the Fed’s new communication approach after the September interest rate decision.
In the view of ANBOUND’s researchers, Warsh’s hawkishness does not necessarily mean immediate rate hikes. It remains possible that he could signal a “modest tightening” trajectory through methods like “quantitative tightening”. On one hand, although U.S. core inflation remains at a high level, July data shows that its upward momentum is insufficient, holding the possibility of a gradual slowdown. On the other hand, the Fed faces not only inflation, but also issues of economic growth and fiscal deficits, requiring it to adopt a balanced approach.
Returning to the inflation target can be seen as a major point Warsh expressed to the outside world. Warsh also spoke at the symposium about his seven implementation principles for the Fed’s monetary policy framework as the core benchmark for the future direction of the Fed under his leadership. According to media summaries, these principles can be generalized as follows. First, policy should follow data-driven guidelines when assessing supply and demand. It should be based on macroeconomic trend data and economic supply and demand. Second, the Fed needs to firmly uphold its policy objectives of inflation rigidity and the dual mandate. It should remain anchored to the 2% PCE core inflation target. At the same time, it should balance price stability and maximum employment. Third, the Fed should strictly follow the tool-based principle. Monetary aggregates should be emphasized as the implementation path. Short-term rates should remain the conventional tool. The use of unconventional tools should be strictly limited, while the impact of monetary aggregates on the macroeconomy should also be considered. Finally, communication should remain restrained. Unnecessary signal release should be reduced.
From these principles, one can discern Warsh’s neoliberal theoretical roots, which are consistent with his propositions prior to taking office, once again disproving the speculation that he is Trump’s mouthpiece at the Fed. This implies that the Fed will continue to shrink its balance sheet down the road, completing Powell’s unfinished business and realizing the normalization of monetary policy. However, although Warsh has repeatedly emphasized market dominance and the necessity of the Fed’s policy exit, judging from actual conditions, the path to normalization is not smooth and is even more difficult than monetary tightening.
First, inflation exhibits greater stickiness. Judging from U.S. retail price performance, the increase in service wages remains prominent, housing rent expectations continue to rise, while the prices of commodities such as energy and food are instead seeing slowed growth. This actually suggests that inflation expectations have normalized, and inflation stickiness is difficult to alter easily. Although Warsh emphasized the benefits of AI development for future growth and efficiency gains, believing it is conducive to lowering inflation, this process is not easy. Moreover, short-term AI investment shows signs of overheating. The track is overly crowded, and it will instead generate bubbles, drive up costs, and cause inflation to rise. At the same time, the process of AI penetration across various fields is also a gradual one, and the pace of its efficiency gains is a long-term process that may exceed Warsh’s term. Thus, the argument regarding AI reducing inflation is likely more of a “gimmick” for the Fed’s current monetary policy and lacks the necessity for a policy framework adjustment.
Second, the U.S. government’s massive debt and deficit increase the difficulty of the Fed shrinking its balance sheet. Under circumstances where U.S. government debt has broken through USD 40 trillion and fiscal deficits continue to expand, both the U.S. fiscal budget and Treasury bond issuance require coordination with the Fed’s monetary policy. On one hand, rate hikes will increase the financing costs of government debt, raise interest expenditure, and further widen fiscal deficits. On the other hand, the Fed’s balance sheet reduction will alter the current supply and demand balance of U.S. Treasury bonds, leading to higher costs for issuing U.S. Treasury bonds. The contradiction between fiscal expansion and monetary tightening is a major root cause of persistently high inflation under previous “Bidenomics”, making Powell heavily criticized for “supporting Democrats” and leaving him unable to realize monetary policy normalization during his term. Whether Warsh can accomplish this process is certainly no easy task, especially since it will likely prove even more difficult during Trump’s term. Therefore, his so-called “hawkish” balance sheet reduction is likely easier said than done.
Third, Warsh’s promotion of financial reform likewise faces side effects. Adhering to the neoliberal market-driven principle, Warsh in fact promotes reduced influence for the Fed and deregulation of financial markets. This point is similar to the Greenspan era and aligns with Wall Street’s interests. However, in terms of timing, financial deregulation implies monetary easing, running counter to policy tightening and potentially generating more chaos. This also means the Fed’s balance sheet reduction is offset by financial institutions leveraging up. With deregulation, U.S. financial institutions are expected to reduce required reserves and release liquidity. Although this may achieve the Fed’s balance sheet reduction, deregulation instead brings about an increase in broad money, equivalent to a disguised form of “mass easing”. Such a result is likely opposed to Warsh’s “hawkish” intentions, will intensify inflationary pressures, and will also impair the Fed’s credibility. This, in turn, will interfere with the execution of monetary policy and the realization of policy intentions.
Judging from the outcome, following Warsh’s speech, after a short-lived rebound in the U.S. Treasury market, U.S. Treasury prices experienced a comprehensive pullback. Regarding short-term bonds, the market believes that the rate hikes are imminent. When it comes to long-term bonds, the yield on the U.S. 10-year Treasury bond returned to a one-year high, and 30-year Treasuries likewise remained stubbornly high. This reflects the market’s doubts over whether the inflation target insisted upon by Warsh can be achieved, and of course, it also reflects anxiety over the uncertainties of U.S. Treasury supply, demand, and maturity changes under fiscal-monetary integration. This cannot be decided by the Fed alone; it is also determined by the market’s doubt regarding the effectiveness of monetary policy.
Final analysis conclusion:
At the Jackson Hole Economic Policy Symposium, Federal Reserve Chair Kevin Warsh outlined the policy direction and basic principles of the Fed’s framework under his tenure. His remarks also showed a “hawkish” foundation. However, achieving the inflation target he emphasizes will not be easy. Inflation remains persistent, while concerns over U.S. Treasuries remain. The market therefore still needs to carefully assess the path of the Fed’s tightening policy.
- Dr. Wei Hongxu is a Senior Economist of China Macro-Economy Research Center at ANBOUND, an independent think tank.
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