Fed Chair Warsh: Recent Inflation Data Better Than Expected, But Not Enough to Prove Material Improvement in Underlying Inflation Trend

TradingKey - Fed Chair Kevin Warsh delivered a speech at the Federal Reserve's annual symposium in Jackson Hole, Wyoming.

He stated that the overall performance of the U.S. economy has been impressive, even showing signs of strengthening recently. Corporate capital expenditures, S&P 500 earnings, consumer spending, and the labor market have all remained resilient, but inflation remains noticeably above the Fed's 2% target.

Warsh pointed out that the Fed's most important task at present is to confirm that underlying inflation is falling at a "clear and sufficiently fast pace." Otherwise, monetary policy may still need further adjustment.

AI Investment Accelerates Corporate Capex

Warsh stated that corporate capital expenditures are a crucial foundation for future economic growth. Currently, four-quarter growth in investment in equipment and intangible assets is around 9%, reaching its highest level since 2021. More than half of this year's capex growth is likely linked to artificial intelligence infrastructure construction.

The AI boom is also changing the investment structure of the U.S. economy. Massive capital is flowing into data centers, chips, cloud computing, and related software, with AI potentially emerging as a new factor of production that could exert long-term impacts on productivity, employment, and monetary policy.

Meanwhile, earnings growth for S&P 500 constituent companies exceeded 20% over the past year, corporate profit margins are at historically high levels, and overall stock market volatility remains low.

However, Warsh emphasized that the Federal Reserve will look not only at the absolute levels of corporate earnings and capital expenditures, but also at changes in their growth rates—the so-called "second derivative of growth." If capex and earnings growth decelerates, it could further affect asset prices, business confidence, household income, and consumer spending.

Financial Conditions Are Not Restrictive

From the perspective of credit markets, U.S. financial conditions remain relatively loose. Credit spreads on corporate bonds and leveraged loans are near historic lows, and issuance in relevant markets has also been robust this year.

The Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Practices released in July showed that banks' underwriting standards for commercial and industrial loans were in a historically relatively loose range, allowing commercial and industrial loans to maintain growth.

Warsh stated that despite pressure in some sectors such as housing and agriculture, on balance, it is difficult for him to describe overall U.S. financial conditions as "restrictive." This means current interest rate levels have not yet exerted a sufficiently strong restraint on economic activity.

Consumer Spending and Labor Market Remain Resilient

U.S. real consumer spending has grown by more than 2% over the past four quarters. Final sales to private domestic purchasers, a key indicator measuring underlying economic momentum, has grown at a rate close to 3% so far this year, typically offering a more useful reference than looking at gross domestic product alone.

The labor market has also remained stable. The U.S. unemployment rate stands at 4.1%, showing little change over the past few years, while the four-week moving average of initial jobless claims is also near multi-decade lows.

Warsh believes that the current low labor market turnover stems in part from the massive post-pandemic labor reallocation. Given the limited growth in labor supply, monthly job gains are naturally not particularly high, but this does not necessarily mean the economy is about to deteriorate.

He pointed out that people who currently want to work are generally still employed or able to find jobs. Although groups such as recent graduates face certain pressures, overall, the U.S. labor market remains consistent with full employment.

PCE Inflation Remains Well Above 2% Target

Compared with the labor market, data on price stability is even more concerning. The Federal Reserve's preferred metric, the personal consumption expenditures (PCE) price index, rose 3.7% over the past 12 months, with the six-month annualized increase reaching 4.1%. Other indicators, such as the Consumer Price Index (CPI), core PCE, and core CPI, also remain at elevated levels.

Warsh noted that while these inflation measures are imperfect, they send a largely consistent message: U.S. inflation remains above the Federal Reserve's 2% target. Therefore, at this stage, the Fed's primary focus should be on prices rather than rushing to pivot toward policy easing.

Looking at the 199 components of the PCE price index, 54% of goods and services saw price increases exceeding 3% over the past 12 months. Although this proportion is down from around 77% post-pandemic, it remains well above the pre-pandemic 20-year level of approximately 32%.

Over the past six months, 49% of PCE goods and services components still recorded annualized price gains exceeding 3%. This suggests that although inflation has pulled back noticeably from its 2022 peak, the improvement over the past two years remains limited.

Fed Needs to Prevent Inflation Expectations From Unanchoring

Warsh noted that while recent PCE and CPI data were better than expected, they are not yet sufficient to prove a material improvement in underlying inflation trends. The recent rise in commodity prices may also bring new inflationary pressures, requiring continued observation to see if it translates into more persistent price risks.

Currently, medium-term inflation expectations remain generally stable, and pricing in the inflation swap market also shows that the market still believes the Federal Reserve can restore price stability.

However, Warsh warned that historical experience shows market inflation expectations often remain stable for long periods until they shift suddenly. Therefore, the Fed must closely monitor inflation expectations to prevent them from becoming unanchored.

He stated bluntly that the central bank should be held responsible for the inflation that has remained persistently high over the past 65 months. The Fed's standard is very clear: policymakers have reason to confirm that inflation is back on track only when underlying inflation moves clearly and rapidly enough toward the 2% target.