Goldman Sachs holds firm on Fed rate pause after Warsh's hawkish remarks

Goldman's analysis counters the market's strong reaction to Warsh's Jackson Hole comments, stating that the threshold for a September rate increase is higher than what the initial jump in hike probabilities suggested. If Hatzius's prediction that core CPI and PCE will come in at around 0.2% for August holds, it would align with recent inflation trends rather than the acceleration Warsh indicated he needs to see. This would likely disappoint traders who, after the speech alone, had pushed the probability of a hike to nearly 60%. A weak result from the upcoming CPI and PPI data would likely cause the short end of the Treasury curve to partially reverse Friday's gains and could relieve equities that declined on rate concerns. On the other hand, a positive surprise in inflation figures would confirm Warsh's perspective and boost the probabilities that markets had already started pricing in, making the next two data releases especially important for the September decision.

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Earlier report:

• Warsh's hawkish Jackson Hole speech boosts rate hike expectations and pressures equities

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Goldman is wagering that the hawkish tone from Warsh will not be backed by similarly hawkish economic data, maintaining its baseline expectation that the Fed will hold rates steady.

Key takeaways:

• Goldman Sachs chief economist Jan Hatzius characterized Warsh's Jackson Hole speech as his most hawkish since becoming Fed chair, focusing on the need to bring underlying inflation back to the Fed's 2% target at a sufficiently rapid pace.
• Warsh admitted that recent PCE and CPI figures were better than anticipated but contended they do not reflect a significant improvement in underlying inflation trends.
• Hatzius noted that the speech leaves room for a September rate increase if upcoming August CPI and PPI data are stronger than expected.
• Goldman's own projection is that core CPI and core PCE inflation will be around 0.2% in August.
• Based on that, Goldman still expects the FOMC to keep rates unchanged at its September meeting.

According to Goldman Sachs chief economist Jan Hatzius, Kevin Warsh's Jackson Hole speech was his most hawkish since becoming Fed chair, but he contends that the change in rhetoric alone is unlikely to result in a rate increase next month. In a client note, Hatzius stated that Warsh made it clear his primary concern is ensuring that underlying inflation returns to the Fed's 2% target in a clear and timely manner, and warned that additional action will be needed if it does not.

Hatzius said that Warsh directly addressed the recent string of positive inflation data, admitting that this summer's PCE and CPI figures were better than anticipated but arguing they do not yet signal a substantial improvement in underlying price trends. Hatzius wrote that this perspective leaves the possibility of a September rate increase open, but only if the forthcoming August CPI and PPI data surprise on the upside.

Goldman's own projections indicate that threshold will not be met. Hatzius said the bank still forecasts core CPI and core PCE inflation to come in at around 0.2% for August, a rate the firm considers too weak to warrant the policy action that Warsh's comments suggested. Accordingly, Goldman's baseline scenario remains that the Federal Open Market Committee will keep rates unchanged at its September meeting.

The note arrives as markets have been reassessing the likelihood of a September move after Warsh's speech, with interest rate futures indicating an increase in the implied probability of a rate hike following his Jackson Hole comments. Goldman's analysis suggests that this repricing might be premature unless the inflation data becomes significantly stronger in the coming weeks, making the August CPI and PPI releases a more critical factor for the September decision than Warsh's rhetoric alone.