Inflation Is Running at 4.1%, Not 3.7%. A Hike Is Now a Coin Flip.

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Updated 1115 ET

Kevin Warsh delivered his first Jackson Hole keynote as Federal Reserve chair on Friday morning. The headline was the arithmetic, not the tone.

Inflation over the past twelve months runs at 3.7% on the personal consumption expenditures index. Over the past six months, annualised, it runs at 4.1%. The shorter window is the hotter one, which is what acceleration looks like.

He went further into the detail than chairs usually do. 54% of the components of that index are rising at more than 3% a year, a share he described as elevated against pre-pandemic norms. Progress over the past two years, he said, has been “modest.”

“Inflation is running above our 2 percent target,” he said. “So the Fed’s predominant focus right now should be on prices.” He called the 2% goal, measured on core PCE, “firm and fixed,” and said the Fed would “have work to do” if it could not confirm inflation was heading there.

What he refused to give was a decision. “I stand here today committed to a discipline, not to a decision,” he said, and defended the absence of forward guidance on the grounds that it “risks creating ambiguity in the name of clarity.”

Markets translated it anyway. The probability of a September rate increase moved from roughly 35% to 57% on CME futures. The two-year Treasury yield rose 11 basis points to 4.34%. The ten-year rose 5 basis points to 4.72%. The dollar index gained 0.6% to 99.66, the yen weakened toward 160, gold slid to about $4,530 an ounce, and the Russell 2000 fell 1.2% while the S&P 500 lost only 0.3%.

Look at which end of the curve moved. The two-year rose more than twice as far as the ten-year, flattening the spread between them from about 44 to 38 basis points. That is what a market does when it believes the central bank will tighten but does not believe long rates will be allowed to follow. The front end is priced by the Fed. The long end now has another bidder.

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THE OPERATION

The word he didn't say

Now the omission. In a speech built entirely around who should set the price of money, Warsh did not mention the Treasury’s bond buyback. Not once. He made no reference to fiscal policy or Treasury operations at all.

This is the same programme the Treasury doubled on August 19, to at least $4 billion per operation in the ten-to-thirty-year sector, for the express purpose of pulling long yields down. It is currently the most active instrument operating on the long end of the American curve, and the Federal Reserve chair spent an hour on the price of money without naming it.

The two men have opposite theories. Scott Bessent argued that rising yields did not reflect economic fundamentals and intervened to correct them. Warsh wants the bond market to do more of the work of setting rates, has criticised large-scale asset purchases, and thinks intervention belongs only in genuine market dysfunction.

The critics are specific. Stanley Druckenmiller called the buyback “price management” rather than liquidity management, and warned it could damage the Treasury’s credibility. Will Compernolle of FHN Financial put it plainly: “There’s very little evidence that Treasuries are oversold right now.” Padhraic Garvey of ING described unscheduled buybacks as a potential “bazooka.”

Hanno Lustig of Stanford identified the deeper cost. Markets have already begun treating Treasuries as risky, while policymakers continue to act as though they are riskless, and intervening in the price muffles the signal that would tell everyone the debt path is unsustainable.

Set that against Warsh’s own stated doctrine. He wants market signals to reach the Fed “unfiltered,” and warns of a “hall-of-mirrors problem” in which the Fed reads a market that is only reading the Fed. He said the central bank should not operate in a world where “market participants are looking primarily to the Fed for their next trade.”

He wants unfiltered signals from a market another arm of the government is actively filtering, and he did not say so. The silence is the position. Acknowledging the buyback would mean conceding that the price of thirty-year money is currently being set at the Treasury rather than the Fed, six weeks after he argued the market should set it. Saying nothing costs him nothing on Friday and cedes the instrument by default.

RULES OF ENGAGEMENT

Where the two policies collide

September 16 is now a genuine coin flip at 57%, and the two-year yield at 4.34% is where that gets priced. Anything on a short reset, a floating rate loan, a card balance or a variable business line, prices off the front end and moves first.

Watch the spread between the two-year and the ten-year rather than either one alone. It closed Friday near 38 basis points. If the Fed tightens while the Treasury keeps buying the long end, that spread compresses further, and a flat curve tightens credit conditions without anyone voting for it.

Friday made the Japanese problem worse, not better. The yen weakened toward 160 on a hawkish Fed, which widens the rate gap that has been pressuring the Bank of Japan to tighten. The BOJ meets in September priced at 87% to move, and every increase raises the return on Japanese institutions bringing money home from the $1.203 trillion of Treasuries they hold.

Gold at roughly $4,530 an ounce is sitting on its 200-day moving average after sliding 1.4% on the speech. That is the first real test of the debasement trade since it started running three weeks ago. A hawkish Fed is the one thing that argues against owning a metal that pays no yield.

Canada’s matching tariffs on about $20 billion of American goods begin on September 8, eight days from now and eight days before the Fed decides. Tariffs raise the price level directly, which means the September vote will be taken with a fresh inflationary impulse already scheduled.

The exposure is a disagreement nobody has admitted to. The Fed chair told the world on Friday that inflation is running at 4.1% over six months, that more than half of all prices are rising above 3%, and that his focus is on prices rather than a decision. The market moved a September hike to a coin flip. And the single largest force currently acting on long-term American interest rates, the Treasury buying its own bonds, went unmentioned. One arm of government is preparing to raise the cost of money while the other spends billions to lower it. Nobody at Jackson Hole said that out loud.

END OF TRANSMISSION.

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