Fed Chair Kevin Warsh Testified Before Congress on July 14 and Said Inflation Remains Too High. A Key Inflation Report Came Out the Same Day. Markets Dropped the Odds of a July Rate Hike to 16%, Down From 42% the Day Before. The Odds Have Since Jumped.

Last week, markets received very mixed signals about the likelihood of a Federal Reserve interest rate hike in July. Fed Chair Kevin Warsh made his debut appearance before Congress on July 14, presenting his semiannual monetary policy report. He painted a picture of inflation that is too high and the Fed's determination to bring it down through monetary policy.

In his prepared remarks, Warsh told members of the House Financial Services Committee that "high inflation has been an undue burden on American households and businesses" and that, if the Fed gets its policymaking right, "the inflation surge of the last five years will be a thing of the past." Warsh added that "the members of our Committee have no tolerance for persistently elevated inflation. And we share a resolute commitment to restoring price stability."

Those remarks by the new Fed chief would suggest that Fed rate hikes, which are generally the central bank's primary tool to tackle high inflation, are imminent.

Federal Reserve Chair Kevin Warsh. Image source: Federal Reserve.

Soft June inflation data suggested rate hikes might not be needed

But on the same day, the Bureau of Labor Statistics published its Consumer Price Index (CPI) data for June. The highly anticipated report showed that inflation finally cooled a bit in June, with the headline CPI down 0.4% from the previous month, the biggest one-month decline since April 2020. And when volatile food and energy costs were excluded, the index was flat month over month, which is still a big improvement from the 0.2% increase in May.

That suggests inflation is finally moderating and that rate hikes by the Fed are not necessary. So which signal -- Warsh or the CPI report -- did the market believe? It went with the data.

The day before the Warsh testimony and the CPI release, traders were pricing in a 42% chance that the Fed would hike its target interest rate by a quarter percentage point at the July 28-29 meeting of its monetary policy committee. After the two events -- the data release and the Warsh remarks -- that dropped to about 16%. A day later, it was down to 12%.

But the odds of a July rate hike moved back to about 34% as of July 22. That's probably because it's become clear that the drop in the CPI index in June was primarily due to a significant decline in the price of gasoline that resulted from the temporary truce between the U.S. and Iran.

Of course, that truce ruptured in early July, and the prices of both Brent crude oil and gasoline spiked again.

Since taking his new position, Warsh has sounded very hawkish. That is, he talks more about dealing with inflation than boosting employment. That suggests a rate hike will happen this year. If not at the July meeting, then perhaps in September or October.

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