Fed Split Over Rates: Why Didn't The Fed Hike Today?

Kevin Warsh · Federal Reserve

Capex is broadening beyond tech, so economic strength isn't confined to narrow AI pockets.

Warsh said the data, including since the last meeting, show the capex story is not just robust and strong but broadening. Business investment is likely rising at about a double-digit pace and capital expenditures are at a historically high share of GDP. High-tech investment leads the acceleration, but other categories are broadening too. He argued that claiming strength is confined to narrow pockets is now a much harder story to tell than several quarters ago.

“the CapEx story is not just robust, not just strong, but it is broadening.”at 15:33

Kevin Warsh · Federal Reserve

Productivity has been rising for a couple of years, mostly predating AI superintelligence.

Warsh believes productivity has improved, though it cannot be measured precisely. He argues most of that productivity change predates the AI advances the market discusses, such as superintelligence. Productivity has been moving higher for a couple of years, which means higher economic growth. He uses this to argue that faster growth is not necessarily causing inflation or making the Fed's job harder.

“My judgment is we have seen an improvement in productivity. We can't measure it precisely. I think most of that change in productivity precedes everything we're talking about super intelligence.”at 19:39

Kevin Warsh · Federal Reserve

Strong growth doesn't mean the economy is overheating or driving inflation.

Warsh said the economy is strong: first-half GDP growth was revised up from 1.8% to 2.4%, and third-quarter growth is likely above 3%, led by healthy consumer spending. The jobless rate is lower than a year ago, payroll growth is above last year's pace, and unemployment insurance claims are at the lowest level in generations. Most colleagues do not judge the economy to be running too hot. Given uncertainty about potential growth and the productivity improvement, higher growth does not in his view mean growth is causing inflation.

“And so economic growth is higher, but that doesn't tell me that economic growth is somehow causing inflation and making our job harder.”at 20:00

Kevin Warsh · Federal Reserve

Inflation remains too high after running above target for close to six years.

Warsh said inflation has run above the committee's objective for close to six years and remains elevated. Energy and related prices have moved higher again in recent weeks. His job is to keep relative price changes in some sectors from broadening across the economy. He stresses the Fed's responsibility to get inflation down, which is why the committee focused on price stability.

“But inflation is too high. Energy and related prices have moved higher again in recent weeks.”at 4:52

Kevin Warsh · Federal Reserve

Market inflation compensation and expectations are moving the right way, a good Fed signpost.

Warsh pointed to market measures of inflation compensation, including swaps and other prices, which he said are going in the right direction. He said expectations might have gone the wrong way absent the Fed's actions, but they have instead gone the right way. He said he feels good about these signposts from the new monetary strategy.

“Inflation compensation as measured by swaps, prices, many other measures, inflation compensation is going in the right way.”at 10:19

Kevin Warsh · Federal Reserve

Employment conditions are quite positive, with lower unemployment and claims at generational lows.

Warsh cited the jobless rate, which is lower than a year ago, and payroll growth that is noticeably above last year's pace. The four-week moving average of unemployment insurance claims continues to run at the lowest level in generations. On this basis he concluded that the employment side of the Fed's dual mandate is in quite a positive place.

“So on the employment side of the Fed's dual mandate, conditions are quite positive.”at 3:00

Kevin Warsh · Federal Reserve

Oil keeps rising on geopolitics, breaking its prior correlation with market interest rates.

Warsh said oil prices and market interest rates moved together this year, a correlation that was quite strong until very recently. Oil has kept rising, largely due to geopolitical events, and crack spreads between oil and refined products remain elevated. Interest rates have rolled over to the downside while oil continued higher. Oil futures have moved up over recent weeks. If oil falls, the Fed would have to examine the effects on its dual mandate and financial markets.

“There'd been a stable correlation between oil prices as they've moved up this year generally and interest rates, not the interest rates that we control, but interest rates set in the market. That correlation has been quite strong until very recently.”at 11:51

Kevin Warsh · Federal Reserve

Interest rates do affect the AI investment boom; they aren't divorced from the economy.

Warsh rejected the narrative that rate hikes would have no effect on AI because investors' expected returns differ. He argued interest rates get into the cracks and affect directly or indirectly almost everything. Since early September, market participants have become more discerning in their capital allocation inside and outside the technology complex. Credit spreads for certain assets have widened and gapped out, while other assets saw some tightening of financial conditions, though not significantly. He concludes that rates do matter for the new technology and investment surge.

“do interest rates matter? I believe they do. And I don't believe that they're somehow divorced from the rest of the economy.”at 15:10