Citi Research says Federal Reserve Chair Kevin Warsh's hawkish tone has raised the odds of a September rate hike, based on a new "Warsh shadow rate" gauge built from the indicators he highlighted at Jackson Hole. Citi still expects the Fed to hold, but says August inflation data will decide the outcome, and a hike would pressure Treasury yields, gold and equities.
The Federal Reserve faces a growing risk of delivering a September rate hike after Warsh signalled a more hawkish approach to inflation, Citi Research said. Softer incoming data could still keep the central bank on hold, the bank added.
A new gauge flashes a hawkish signal
Citi constructed its "Warsh shadow rate" from the economic and financial indicators Warsh highlighted in his Jackson Hole speech. The gauge is close to historical highs typically associated with past Fed hiking cycles, and it tends to lead two-year Treasury yields, suggesting markets may be correctly pricing a higher probability of renewed tightening.
Warsh placed greater emphasis on underlying inflation, money supply, labor-market claims, financial conditions and equity-market indicators, while playing down inflation expectations, wages and headline nonfarm payrolls. Citi said the indicators Warsh prioritized are predominantly showing a hawkish signal, while many of the measures he downplayed have softened.
August inflation is the decisive test
Citi economists still do not expect a September hike, arguing that softer inflation data could prevent one. However, a 0.3% or higher rise in core CPI would probably make a hike more likely, while a 0.1% increase could postpone it. The implications of a 0.2% reading would be less clear.
Markets brace for the fallout
A more hawkish Fed has already pushed Treasury yields higher, with the 10-year yield particularly affected, while rising oil prices have added to pressure on the long end of the curve. Citi said it could become harder to keep the 30-year yield below 5.3% if the Fed begins hiking in September, a growing challenge for U.S. Treasury Secretary Scott Bessent.
Therefore, a strong August inflation reading could turn the September meeting into a live hike decision, threatening to push yields higher and weigh on gold, while stocks may prove more resilient unless rising rates come with a sharp jump in volatility. Citi's historical analysis found equities typically weaken for roughly 50 trading days after a first Fed hike before recovering, whereas bond returns can remain weak for much longer.
Source: Investing.com
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