Warsh's hawkish stance reignites expectations of rate hikes: the probability of a September rate hike rises to nearly 60%, with two rate hikes potentially occurring before March 2027.

Federal Reserve Chairman Warsh's speech at the Jackson Hole symposium on Friday reignited market bets on a Fed rate hike. While Warsh did not provide direct policy guidance for the September meeting, he made it clear that policymakers must be convinced that underlying inflation is falling "clearly and quickly enough" toward the 2% target, otherwise the Fed "still has work to do."

This statement quickly altered interest rate pricing. Media reports indicated that market activity showed traders were resuming betting on a 25-basis-point rate hike this year, and were inclined to bet on two possible rate hikes by March 2027; CME data showed the probability of a September rate hike rose from approximately 35% before Warsh's speech to 50%, while other market data initially indicated a probability of around 55%. Subsequent reports stated that market data showed this probability had reached approximately 60% at one point.

Polymarket, a market forecasting firm, has raised its probability of a Fed rate hike in September to over 50%.

The market's renewed bets on interest rate hikes are not due to Warsh's explicit announcement of a September rate hike, but rather because he, for the first time as Federal Reserve Chairman, systematically outlined his policy response criteria: the 2% inflation target is a "firm and fixed" goal; recent inflation data is insufficient to demonstrate a significant improvement in the underlying trend; and US financial conditions are not tight. Under this policy framework, if inflation continues to exceed the target, a rate hike naturally becomes a realistic option again.

"There's still work to be done," markets are re-betting on a September rate hike.

The most attention-grabbing part of Warsh's speech was the following statement:

“We must be certain that underlying inflation is moving toward our target, and is moving clearly and quickly enough. Otherwise, we still have work to do.”

Walsh did not directly define "there is still work to be done" as "interest rate hikes are needed," but the market clearly interpreted it as retaining the possibility of further policy tightening.

Bloomberg data shows that after Warsh's speech, the implied yield on SOFR futures rose by as much as 6.5 basis points compared to before the speech. Traders are reassessing for a 25 basis point rate hike this year and are beginning to favor betting on two possible rate hikes by March 2027.

The most significant change was in the probability of an interest rate hike at the September meeting.

Reuters reported that after Warsh's speech, market bets on a September rate hike increased significantly, with the probability rising from about 35% before the speech to about 50%, and even reaching about 55% at one point during the session. Subsequent market data reported by Reuters showed that the probability had reached about 60% at one point. This means that the market's assessment of the September 16 meeting has quickly shifted from "the probability of a rate hike is significantly low" to at least "50/50".

Meanwhile, another set of Reuters market data showed that the probability of a September rate hike rose to 55.7% at one point during the trading session. While quotes varied at different times, they all pointed in the same direction: Warsh's speech significantly increased market bets on a September rate hike.

The market is also betting on two rate hikes before March 2027.

Market changes are not limited to the September meeting.

Bloomberg data shows that traders are not only preparing for a 25-basis-point rate hike this year, but are also starting to bet on two possible rate hikes by March 2027.

In other words, Warsh's speech not only changed expectations about whether there would be an interest rate hike at the next meeting, but also, to some extent, altered the market's assessment of the policy path for the next few FOMC meetings.

This change is closely related to Walsh's assessment of the economy in his speech.

Warsh believes that the U.S. economy remains resilient: corporate capital expenditures are growing strongly, corporate profits are up about 20%, consumption is up nearly 3%, the unemployment rate is about 4.1%, and initial jobless claims are at a low level.

At the same time, he said:

"I find it difficult to describe the overall financial environment as restrictive."

If the economy does not show a significant slowdown and the financial environment does not tighten significantly, and if inflation remains above the target, the market will naturally believe that the Federal Reserve has room to further raise interest rates.

Warsh did not promise a September rate hike, emphasizing "discipline" rather than a specific decision.

However, it should be noted that the market's renewed bets on interest rate hikes do not mean that Warsh has explicitly committed to a rate hike in September.

On the contrary, a key feature of Walsh's speech was his opposition to forward guidance in the traditional sense.

He stated:

“A quieter, more communicative Federal Reserve is better able to achieve its goals.”

Warsh argues that the Federal Reserve should not allow the market to rely too heavily on its descriptions of the future policy path, nor should it issue a mechanical policy response function.

At the end of his speech, Walsh further stated that he was " committed to following a discipline, rather than (pre-committing) to a particular decision."

This means that Warsh is essentially telling the market that he can clearly state the policy principles, but he will not tell the market in advance whether the next meeting will raise interest rates or keep them unchanged.

Therefore, whether or not interest rates will be raised at the September meeting will still depend on the inflation and employment data to be released in the coming weeks.

Future data will be key to the September meeting.

Walsh's speech provided the market with clearer policy "discipline," but did not offer specific policy "answers."

What the market really needs to focus on right now is whether the inflation data to be released in the future will show a clear and sufficiently rapid trend of "underlying inflation" falling back towards the 2% target, as Walsh described.

If the data continues to show that inflation is sticky, then this speech has left enough room for further interest rate hikes; conversely, if inflation cools down significantly in the future, bets on a September rate hike may quickly fall back.

Therefore, the most important impact of Walsh's speech was not that he "announced" a September rate hike, but that he brought the rate hike back into the market's baseline scenario discussion .

As of now, the market has rapidly shifted from a probability of a September rate hike of about 35% before the speech to about 50% or even higher, and has begun betting on two possible rate hikes in the coming months. In other words, Warsh did not provide a clear interest rate path, but successfully got the market to start pricing in "higher interest rates" again.

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