Warsh comments shift dial on Fed hikes

August turned out to be a surprisingly action-packed month for the dollar, which was buffeted first by the surprise news of an increase in the Treasury's buyback operations, and then by notably hawkish remarks from FOMC Chair Warsh on Friday. Speaking at the annual Jackson Hole symposium, Warsh noted that while recent US inflation readings had been better than expected, the Fed would still have "work to do" if policymakers weren't confident that underlying inflation was moving towards target clearly and at sufficient speed. The market's response was a knee-jerk dollar rally late last week, which reversed most of the greenback's month-to-date losses.

Warsh's remarks have been enough to shift the dial dramatically: markets have pivoted from seeing a September Fed hike as fairly unlikely to now treating it as the base case. We are somewhat conflicted. While the ongoing war in Iran and elevated oil prices make a September hike plausible, the absence of second-round inflation effects, a cooling jobs market and the rise in Treasury yields (that Warsh himself has said partly does some of the Fedˇs job for it) mean we're not rushing to change our call for no change just yet. This may change, however, particularly as it may be difficult for the Fed to disappoint markets that now see more than a two-in-three chance of a hike later this month.