Federal Reserve Chair Kevin Warsh, in his first external appearance since taking office, said inflation risks have diminished but pledged to bring the inflation rate down to the central bank's existing 2% target without fail. He kept silent to the end about the direction of monetary policy to be addressed at the Federal Open Market Committee (FOMC) regular meeting on the 28th and 29th of this month, but effectively sent a message that he would not blindly agree to the rate cut President Donald Trump wants. Warsh also reiterated his intention to pursue quantitative tightening (QT), the reduction of the Fed's balance sheet, over the long term. The market placed priority on Warsh's inflation remarks, interpreting them as a hawkish signal favoring monetary tightening.
Kevin Warsh's first external remarks weigh on stocks... deflects on July rate hike
On the first trading day of the second half of the year, Monday in New York, the Dow Jones Industrial Average (-0.03%), the Standard & Poor's 500 index (-0.22%), and the Nasdaq Composite index (-0.66%) all declined. The impact was especially large from a flood of profit-taking in semiconductor-related stocks, including Nvidia (-1.25%), Broadcom (-2.23%), Micron (-10.57%), AMD (-6.89%), Intel (-9.03%), Applied Materials (-9.97%), Lam Research (-9.71%), and SanDisk (-10.62%). The Philadelphia Semiconductor Index also plunged 6.27%.
The direct cause of the New York market's decline that day was weakened investor sentiment toward semiconductor-related stocks, but Warsh's first public external remarks also had an indirect effect. On Monday, Warsh appeared as a panelist at an annual policy forum hosted by the European Central Bank (ECB) in Sintra, Portugal, alongside ECB President Christine Lagarde, Bank of England (BOE) Governor Andrew Bailey, and Bank of Canada (BOC) Governor Tiff Macklem, explaining the Fed's future.
Warsh first raised the topic of forward guidance—advance guidelines on the direction of monetary policy—which was abolished at the FOMC meeting on the 16th and 17th of last month, the first he presided over. "At the last press conference, I said, 'Since there's a meeting in six weeks, I won't provide forward guidance,' but there's something new to tell you," Warsh opened. Yet when the moderator immediately asked point-blank, "Is a rate hike on the table for discussion at the July meeting?" Warsh deflected, saying, "You're trying to get me to break the rule (of not providing forward guidance), but you'll fail." Warsh added, "There's a lot of data we've received," and "I hope that when we meet in four weeks we'll have a great family fight (internal debate), and once we close the meeting room door, we'll have a good discussion." This confirmed once again that the policy of abolishing forward guidance would continue.
Warsh also brushed aside with a somewhat unclear answer the moderator's question of "whether inflation was a temporary phenomenon resulting from rising energy prices." He explained, "If we make progress on productivity, data, and a new inflation framework, then all of us will be able to use them," and "Monetary policy ripples from one part of the economy to another and then comes back, so all of us are receiving a series of shocks." Warsh further stressed, "In the United States, the AI shock is leading to a capital expenditure boom," and "We're seeing this first on the demand side, but I'm confident that at some point we'll see it on the supply side as well."
When the moderator once again posed a leading question—"Does the AI capital expenditure boom cause inflation?"—Warsh drew a line, saying, "In the short term it can be observed on the demand side, but judging whether that is inflation is the central bank's role," and "I'm only asking whether it seeps into a broader range of goods; there's no new news to report." He continued, "Another part I'm paying attention to is that the AI boom shows some differences between countries," and "The AI boom began in the United States and has been very prominent so far, and I'm confident that now, when companies are spending massive amounts of capital, is better than the days when they failed to generate profits, bought back their own shares, and abused financial engineering."
"AI will create more jobs... inflation risk has eased, but prices are still too high"
Warsh predicted that current AI investment would also have a massive impact on future monetary policy. "Right now, companies are investing in the future on the expectation that the supply side of the economy will expand, and if that actually happens, it will have a tremendous impact on monetary policy," Warsh said, adding, "As a central bank person, this is the most exciting period I can think of and a moment with momentous consequences, but I won't make a judgment now." Warsh also said, "It matters because, like 'Moore's Law' (the law of technological advancement that the performance of semiconductor integrated circuits doubles every two years), the rate of improvement in AI models is moving at an exponential level," and diagnosed, "The United States is highly likely to be a big winner in the AI field over the medium term." He continued, "The United States does not fear productivity-driven economic growth, but it also does not continue to bear the costs," and pointed out, "Encouraging economic growth to spread more broadly to the United States through other countries' failures is different from making things easy."
Warsh also offered an optimistic view on the future of the labor market following AI development. Mentioning the economic term "lump of labor fallacy," Warsh emphasized, "Who would have known the internet would create 1.5 million jobs like Uber drivers?" and "We're in the early stages of an AI revolution in which the vast paradigm of policy and the economy as a whole is shifting, and I think job creation will become even stronger." The lump of labor fallacy refers to the economic misconception that society's total number of jobs is fixed.
Warsh said the Fed must deliver results on both employment and price stability, while highlighting the part where he said "the labor market is stable" at the June FOMC meeting. "We said the demand side of the economy is solid, and we also said the capital expenditure and productivity supply side is strong," Warsh said, adding, "We're before seeing the fruits of AI, and we're doing the work of price stability." This effectively meant that, of the Fed's dual mandate of employment and prices, it is currently placing more emphasis on inflation stability. "Over the past two days I've heard open-minded thoughts about AI's productivity, but after looking around, I confirmed that prices are too high," Warsh stressed, adding, "The idea of achieving price stability is not mine alone."
Even so, when the moderator asked, "Are you saying the market was right to interpret the first June press conference as hawkish?" Warsh was somewhat evasive. "Inflation expectations and risks have come down over the past four weeks," Warsh said, while also explaining, "If households, businesses, or financial markets expect the Fed to settle for inflation above 2%, they will probably be disappointed." He added, "Since it's what the Fed has pledged and set as its goal, we will achieve price stability in the United States." This is interpreted as a reference to the situation in which international oil prices are recovering and prices are showing signs of calming as the United States and Iran recently entered ceasefire negotiations. It is also interpreted as expressing concern that various price indicators—the consumer price index (CPI), producer price index (PPI), and personal consumption expenditures (PCE)—all still exceed the Fed's 2% target without exception. According to recent data, core price indices excluding volatile food and energy also exceed 2%.
Draws a line on Trump's 'rate cut' pressure... reaffirms commitment to balance sheet reduction
Warsh, on the president
