Original Title: What Wall Street Thinks Kevin Warsh Will Say at Jackson Hole
Original Author: Stephen Innes
Translation: Peggy

Editor's Note: Following the NVIDIA earnings report, market attention has shifted to the last important event of the week: Federal Reserve Chair Kevin Warsh's keynote speech at the Jackson Hole Global Central Bankers' Symposium. With U.S. inflation still above the 2% target and three officials advocating for a rate hike at the July FOMC meeting, Warsh has not clearly specified the conditions under which the Fed would tighten its policy.

What truly troubles the market is not whether Warsh leans hawkish or dovish, but the Fed's policy reaction function becoming increasingly hard to assess. The policy reaction function refers to how policymakers will adjust interest rates based on changes in inflation, employment, and financial conditions. Warsh tends to reduce forward guidance, but following the July press conference, long-term Treasury yields and market inflation expectations rose in tandem, showing that "less talk" may also increase policy uncertainty.

In this article, Stephen Innes synthesizes views from institutions such as Goldman Sachs, Deutsche Bank, and Bank of America and judges that Warsh may focus on AI, productivity, and long-term policy frameworks rather than directly telegraphing the September rate decision. However, the market still hopes he will address several more specific questions: Is the 2% target explicitly measured with PCE inflation? If inflation remains elevated, is a rate hike still the primary tool? Is the rise in long-term yields a necessary tightening of financial conditions or a policy uncertainty risk premium that needs to be eliminated?

The importance of these questions lies in how Warsh's expression could impact the U.S. Treasury yield curve, beyond just the interest rate expectations for the next meeting. The Treasury Department has just expanded long-term Treasury repurchases, and if the Fed can reduce inflation and the policy uncertainty risk premium, long-term yields may be temporarily constrained; however, the pressure from fiscal deficits, massive financing needs, and supply-demand dynamics from AI capital expenditures will not disappear because of this.

Below is the translated passage:

Following the NVIDIA earnings report, the market has shifted its focus to the last significant event of the week: Federal Reserve Chair Kevin Warsh will deliver the Jackson Hole keynote speech on Friday at 10 a.m. New York time.

This year's conference theme is "Financial Innovation: The Impact on Payments and Policies," but Warsh may not necessarily focus mainly on the payment system. He has previously stated that the speech could take two forms: one discussing long-term structural issues in a "big-picture speech" and the other closer to traditional forward guidance, setting the stage for monetary policy discussions from September to December.

According to Innes, the Goldman Sachs trading division believes that this speech may affect the term premium in the U.S. bond market. Recent inflation data improvement has reduced the immediate need for the Federal Reserve to further tighten policy, providing Powell with an opportunity: he can reiterate his stance on fighting inflation while avoiding directly hinting at a near-term rate hike.

The issue at hand is that what the market currently lacks is not a simple hawkish or dovish label, but a framework to understand the Fed's next steps.

Two Speech Paths: Discussing AI or Addressing Year-End Action

Since taking office, Powell has been more inclined to discuss macrostructural issues rather than provide explicit short-term rate guidance. If this speech continues in this style, the emphasis may fall on topics such as the Fed's internal working groups, productivity, population structure, and artificial intelligence.

The Federal Reserve has already announced the leaders of several special working groups, their research direction, and expected timelines. However, it is still unclear about the specific responsibilities of each working group, how they will collaborate with the FOMC and Fed staff, when they will present their conclusions, and how their recommendations will feed into the policy framework. Powell has stated that he will assess the progress of the working groups between the July meeting and the Jackson Hole symposium, but at this stage, it may still be insufficient to draw substantive conclusions.

Compared to the working groups, AI is more likely to be the focus of this speech.

Powell has previously regarded AI as one of the most significant changes in the economic, business, and household sectors in his lifetime, emphasizing the enormous opportunities and risks it presents. He has also suggested that AI could act as a significant force pulling inflation down by improving productivity, enhancing U.S. competitiveness.

This set of views may influence Powell's understanding of the relationship between economic growth and inflation. If productivity gains allow the economy to grow faster while avoiding an equivalent level of price pressure, the Fed may not necessarily need to tighten policy immediately just because of strong demand, as it did in the past.

However, the short-term impact of AI is not only about downward inflation. The cited institutional judgment shows that AI-related demand is also driving up prices for some consumer electronics and memory products, while the capital spending of hyperscale cloud providers may continue to support investment demand. Therefore, how Powell distinguishes between the short-term demand shocks of AI and its long-term productivity effects may be more critical than simply emphasizing "AI lowering inflation."

Another possibility is that Powell will use Jackson Hole to clarify the policy path by the year-end. This is also what the market is more eager to hear but is harder to predict.

What the Market Awaits Powell to Clarify Is Not Just Whether There Will Be a Rate Hike in September

Powell tends to reduce forward guidance, rarely articulating his and the entire FOMC’s policy reaction function. According to his logic, providing fewer central bank conclusions can force markets to more directly price in economic data, thereby offering clearer signals on financial conditions to policymakers.

The issue, however, is that when the central bank does not explain how to interpret this data, reducing communication may also increase risk premiums.

Deutsche Bank believes that Powell needs to address at least three issues this time.

First is the Fed's inflation target and policy tools.

During the July press conference, Powell did not explicitly commit to using PCE inflation as the 2% target metric, nor did he clearly state whether rate hikes would still be the primary tool for further policy tightening if inflation continued to run high. This has led the market to question whether the Fed will wait for the internal working group to complete its study before taking action.

If Powell explicitly reaffirms the 2% PCE inflation target and confirms that the policy rate remains a core tool to control inflation when necessary, he can address this uncertainty at a lower cost.

Second is how the Fed assesses inflation risks.

The June FOMC minutes presented two basic scenarios: if inflation gradually recedes, rates can remain unchanged and may even fall later; if inflation remains persistently high, further policy tightening may be necessary.

Currently, several inflation forces are moving in different directions. Demand related to AI and energy price pressures from the Middle East has strengthened, while the impact of tariffs may be gradually diminishing, and recent inflation data has been relatively moderate. Powell needs to explain how the Fed weighs these conflicting signals instead of just emphasizing one variable.

Third is financial conditions and long-term rates.

Previously, Powell put forth two seemingly contradictory but actually valid explanations: if bond yields decrease, it may reflect growing market confidence in the Fed's inflation control; if bond yields rise, it would tighten financial conditions from the market side, which could also reduce the need for further rate hikes.

However, this explanation has yet to address a key question: as long-term yields are currently rising, does this reflect a reasonable assessment of economic and inflation risks, or does it include an additional uncertainty premium due to unclear Fed communication?

Goldman Sachs Baseline Scenario: Reaffirming the 2% Target but No Preview of September Action

According to Innes' account, Goldman Sachs expects Powell to focus on three areas in his speech.

First, reaffirm my and the FOMC's commitment to restoring inflation to 2% and may explicitly target PCE inflation.

Second, explain why he leans towards reducing forward guidance. Powell may believe that reducing the central bank's hints about future interest rate paths can allow the market to more directly respond to economic data.

Third, discuss long-term impacts of productivity, demographic trends, global shocks, and AI. The potential of AI to boost productivity and create downward pressure on inflation may once again be a focus.

Goldman Sachs expects Powell to acknowledge an improvement in June and July inflation data but will not clearly suggest a rate decision in September. The bank also expects both core CPI and core PCE in August to increase by around 0.2% month-over-month; the statistical method adjustments implemented at the end of September may lead to at least a 0.2 percentage point drop in year-over-year core PCE growth, although some of this decline may be reversed in subsequent data revisions.

Based on this assessment, the U.S. is likely to see three consecutive months of relative improvement in inflation data. Consequently, Goldman Sachs believes that the most substantial impacts of tariffs, oil price shocks, and AI-related demand on inflation may have passed, and the FOMC is likely to maintain rates unchanged in September and through the end of the year.

This remains Goldman's base case and does not represent Powell's or the FOMC's predetermined policy path. Officials who favored a rate hike in July may continue to hold their original stance, but with improving inflation data, the majority of members, especially the majority of voting members, may be more inclined to stay put.

Bank of America's August fund manager survey also shows that market expectations for a notably dovish Powell are not high: 53% of respondents expect a neutral speech, 31% anticipate a hawkish tone, and only 7% expect a dovish stance.

Why a "slightly hawkish" tone may actually reduce long-end risk premiums

The Jackson Hole Symposium has long been a key event for Fed Chairs to adjust market policy expectations. During his tenure, Powell has often used this platform to provide policy guidance, while Yellen notably spoke less about personal policy preferences and current economic conditions.

This difference has already impacted market pricing.

According to the original text data, after Powell's July press conference, the S&P 500 fell by 1.5%, the 30-year Treasury yield rose by 11 basis points, and the 2-year yield decreased by about 1 basis point. Subsequently, the stock market gradually recovered, but the yield curve continued to steepen, with long-term yields rising more than short-term ones, and gold also showed significant strength.

Innes sees these market moves as investors demanding a higher premium for policy uncertainty and inflation. However, the volatility across asset classes is influenced by multiple factors, and not all changes can be attributed to Powell's press conference.

Nevertheless, the divergence in yields between the short and long end still reveals a market concern: the issue may not just be whether the Fed will hike rates, but also its ability to control long-term inflation and maintain policy credibility.

In this context, a dovish tilt may not necessarily steepen the entire yield curve. If Powell clearly states that inflation has remained above target for too long and that the policy rate is still the primary tool to restore price stability, the market may price in some tightening risks back into short-term rates; at the same time, an improvement in Fed credibility could push down the inflation and policy uncertainty premium embedded in the 10-year and 30-year yields.

From a market pricing perspective, this combination could manifest as pressure on the short end, a flattening yield curve, support for the US dollar, and a dampening effect on the recent strength of gold, commodities, and cryptocurrencies. This is a scenario analysis, not a definitive outcome.

Conversely, if Powell continues the vagueness of July, investors may keep increasing their demands for compensation for long-term inflation and policy uncertainty, keeping long-term yields, gold, and other inflation-hedging assets sensitive.

The Treasury Department Can Stabilize Trading but Won't Fix Long Bond Supply-Demand

Powell's speech comes against a backdrop where the US Treasury Department has just expanded liquidity support repo for the 10- to 30-year Treasury bonds. This arrangement can enhance the liquidity of older securities and signal to the market that the Treasury Department is more focused on the trading conditions of the long end, but it is not equivalent to Fed quantitative easing and will not directly reduce the US government's net financing needs.

Innes believes that if Powell can reduce the inflation uncertainty premium, coupled with the Treasury's long-end buyback arrangement, long-term Treasury yields may be somewhat constrained in the short term.

However, this combination still does not address underlying issues, including the US government's sizable financing needs, persistent fiscal deficits, the potential impact of rising commodity prices on core PCE, and the massive capital expenditures by hyperscale cloud providers on AI infrastructure.

Therefore, what the market needs to observe next is not just whether Powell will use phrases like "inflation still too high" or "recent data improvement," but whether he can answer three questions: whether the Fed still targets PCE inflation explicitly at 2%; if inflation reaccelerates, whether the policy rate remains the primary tool in response; to what extent the rise in long-term yields represents a necessary tightening of financial conditions and how much comes from policy, inflation, and fiscal outlook uncertainty premiums.

Warsh may not need to give the answer to the September resolution, but he needs to tell the market how the Fed will arrive at the answer.

[Original Article]

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