Market Repricing: Rate Hike Probability Surges On August 28, 2026, Federal Reserve Chairman Kevin Warsh delivered his first keynote address at the Jackson Hole Economic Policy Symposium. The market reacted swiftly; the CME FedWatch tool showed that the probability of a 25 basis point rate hike at the September 16-17 FOMC meeting rose from approximately 40% before the speech to a range of 56.9% to 63%. This repricing reflects the market's hawkish interpretation of Warsh's remarks. The current target range for the federal funds rate is 3.50%-3.75%. Warsh explicitly refused to provide forward guidance in the traditional sense, emphasizing that in normal times, excessive guidance could create ambiguity rather than clarity and stifle decision-making flexibility. He pointed out that the forward guidance used during the financial crisis is "outdated," and the Federal Reserve should rely more on market signals—asset prices, Treasury trading, the dollar exchange rate, credit costs, and commodity prices—to assess the economic and inflation outlook. Inflation Focus: The 2% Target is "Firm and Fixed" Warsh clearly focuses policy on price stability. He pointed out that the 12-month PCE price index was 3.7% year-on-year, and the six-month annualized rate reached 4.1%; core PCE and CPI-related indicators were also high. The latest July data shows that PCE remained at 3.7% year-on-year, and core PCE was 3.3%, both significantly higher than the 2% target. He emphasized, "Inflation is running above our 2% target. Therefore, the Fed's primary focus right now should be prices." He further broke down the PCE basket: Over the past 12 months, 54% of goods and services prices rose by more than 3%; over the past six months, that figure was 49%. While this is lower than the post-pandemic peak of about 77%, it is still far higher than the pre-pandemic level of about 32%. Warsh acknowledged that some PCE and CPI readings in the summer were better than expected, but "didn't tell me that the underlying trend has meaningfully improved." He set a standard: "We must be confident that underlying inflation is clearly moving toward the target at a sufficient pace. Otherwise, we still have work to do." Regarding inflation expectations, Warsh believes the current anchoring is good, but it must be closely monitored to prevent decoupling. He explicitly attributed the responsibility for the 65-month-long period of high inflation to the central bank, reiterating that the 2% PCE target is "firm and fixed," and that price stability is not automatic, nor does inflation necessarily revert to the mean. Labor Market and Financial Conditions: Policy Space Under Full Employment With the unemployment rate hovering around 4.1%, Warsh judged that the labor market is broadly in a state of full employment. At the same time, he stated that it is difficult to describe overall financial conditions as restrictive: credit spreads are near historical lows, and bank lending standards are loose. This assessment suggests that the current policy rate has limited constraints on the economy, and if inflation fails to fall sustainably, the need for further tightening will increase. Warsh emphasized that the dual mandates are not contradictory: high inflation itself harms prosperity and employment. Short-term interest rates remain the primary tool, and unconventional policies should only be used during genuine crises. A key aspect of his speech was reshaping the relationship between the Federal Reserve and the market. Warsh warned of the "mirror hall" problem: if the market relies excessively on Fed guidance, and the Fed relies on market prices, both sides are more likely to ignore new policies, increasing the risk of policy mistakes. The real victims are ordinary people without financial assets. He argued that market participants should independently track real economic data and form their own expectations for output, employment, and inflation. This stance aligns with Warsh's previous advocacy for a "quieter Fed." He has established several working groups covering communication, employment and productivity, data, inflation, and balance sheets, aiming to create alternative mechanisms for forward guidance. The speech itself deliberately avoided providing specific policy paths or reaction functions, emphasizing a commitment to "discipline, not a decision." Market Impact and Asset Class Risks Rising interest rate hike expectations are putting pressure on risk assets. The stock market faces valuation compression risks, especially for interest rate-sensitive growth and technology stocks; precious metals and cryptocurrencies, as liquidity-benefiting assets, may face sell-offs; the US dollar may strengthen, putting pressure on emerging market currencies. The US Treasury yield curve may steepen or shift upwards overall, further increasing fiscal interest payments and exacerbating federal budget pressures. AI-related investment and productivity gains are seen as long-term positive factors. Warsh mentioned that AI may become a new factor of production, driving potential growth, but its net effect on inflation and employment in the short term remains uncertain. The working group will study this in depth, but these discussions will not affect the current policy cycle decisions. As of the end of August, market pricing indicated a greater than 50% probability of a rate hike in September, with a high likelihood of further action in October and December. Warsh's statement that "there is work to be done" has been interpreted as a signal of maintaining or even favoring a rate hike, especially given the coexistence of sticky inflation and loose financial conditions. However, the speech also left room for data reliance. If subsequent employment or inflation data weakens significantly, the committee may still choose to wait and see. Warsh emphasized trends rather than single-month data, and pointed out that policymaking must be based on information that is as timely, accurate, and actionable as possible. Geopolitical, supply chain, and technological changes have increased the difficulty of forecasting, and a humble attitude was repeatedly emphasized. Warsh proposed several principles: distinguishing between news from the end of last month and current reality; acknowledging that aggregate supply cannot be directly observed; adhering to the 2% target; balancing the dual mandate; and using short-term interest rates as the primary tool. These principles point to a policy framework that emphasizes discipline and reduces excessive communication. For investors, this means potentially increased volatility. The lack of clear guidance will amplify data-driven and event-driven trading, potentially highlighting the advantages of insider and professional information. On the fiscal front, higher interest rates will push up debt servicing costs, testing the sustainability of US fiscal policy. Overall, the Warsh-Jackson Hole speech did not offer a definitive commitment to rate hikes, but by emphasizing inflation stickiness, a shift in policy focus, and an assessment of financial conditions, it significantly raised market pricing in tightening risks. Ahead of the September meeting, inflation data, employment reports, and financial market signals will continue to dominate expectations. The Fed is attempting to shift from "guidance-dependent" to "signal-driven," and the effectiveness and costs of this shift will be tested by the market in the coming months. It's worth noting that if hawkish rhetoric about interest rate hikes can have the effect of raising rates without actually doing so, this tactic has already been used up, and it damages the Fed's credibility. Even though the Fed claims it will rely on "signal-driven" growth and try to break free from "guidance-dependent" practices, in reality, the Fed is still deeply embroiled in psychological warfare, and the situation will become even more complicated with the US midterm elections approaching. This shows that the Fed's so-called policy space is becoming increasingly narrow. Things are getting worse...
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