Warsh Overhauls How the Fed Talks and Keeps Markets Guessing on Rates

Kevin Warsh used his first meeting as Federal Reserve chairman to put his stamp on how the central bank operates and communicates.

He trimmed its policy statement, declined to submit a rate forecast of his own, and launched five task forces to study everything from how the Fed communicates to how it analyzes the economy—a sweeping reach into how the central bank operates.

About the things markets most wanted to understand—how the new chairman reads the economy and translates it into policy—he said almost nothing. Pressed later on inflation, on whether policy was restrictive and on the future of the so-called interest-rate dot plot, Warsh repeatedly demurred. “We have a task force for that.”

On one point he was emphatic: The committee was united and determined to bring inflation down. “We’ve missed for five years, and we’re going to fix that,” he said, pledging that the committee would “unambiguously and unanimously” deliver price stability.

But he declined to say whether that meant raising rates. “The good news is we’ll be meeting in six weeks.”

By removing the so-called forward guidance (i.e., verbal or written hints) and sitting out the projections, Warsh put aside the tools his predecessors used to steer expectations. That left the committee’s direction an open question at a moment when its members are split down the middle. Nearly half thought rates should be at the current level by year-end, while the other half thought they should be higher. (…)

Telling markets what the Fed might do at its next meeting is one thing, said Michael Feroli, chief U.S. economist at JPMorgan. Explaining the framework by which it responds to a hotter economy or rising prices is another. “That’s not forward guidance. That’s having a framework,” he said.

Warsh, he argued, had used objections to the former to quietly sidestep the latter. By the end of the news conference, Feroli said, he was no closer to knowing how the committee now reasoned about policy. “It matters to have some sense of how this committee is thinking about how it goes about conducting this business,” he said.

That kind of explanation is standard among major central banks. The Bank of England and the European Central Bank both publish detailed accounts of their reasoning, and Warsh’s three immediate predecessors used the postmeeting news conference largely for that purpose. (…)

The meeting “ushered in a new era of monetary policy” in the U.S., said Rick Rieder, BlackRock’s chief investment officer for fixed income, whom President Trump interviewed this year for the job that went to Warsh. Rieder said less communication could reduce volatility if it builds confidence. (…)

The official statement’s only 2 sentences:

Economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East. Productivity growth and capital investment are strong. Job gains have kept pace with the workforce, and the unemployment rate has changed little.

Inflation remains elevated relative to the Committee’s 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. The Committee will deliver price stability.

A solid economy, an OK labor market but too high inflation. “The Committee will deliver price stability.”

Then in his presser, to make sure the message was clear: “The commitment to deliver is strong, unanimous and unambiguous,” he said in response to a reporter’s question. “And that’s, I think, an important message. We missed for five years, and we’re going to fix that.”

That’s clear guidance for me.

So was the dot plot:  Nine of 19 officials penciled in at least one rate increase by year’s end, up from none in March. Just one foresaw a cut, down from 12. The average projected rate by the end of this year has risen from 3.24% to 3.83%.

“We have the capability and commitment to deliver on our price stability objective,” said Warsh. “That’s exactly what we’re going to do.”

Warsh and the FOMC could have used the fall in oil prices to duck the inflation risk. There was none of that. Maybe yesterday was Kevin Warsh’s independence day!

Rob Kaplan, vice chairman at Goldman Sachs Group Inc. and former Dallas Fed president in Bloomberg:

“If inflation prints don’t cool between now and we get to September, I actually think the balance of risks suggests it would be wise to take some action, either in September or in the fall,” Kaplan said in a Bloomberg TV interview. “That’d be the wiser thing to do.”

He also noted that Fed policy moves rarely occur as one-off actions, with rate changes more often coming in a series of two or three. “So I think if you move in September, you need to be prepared. There could be one or two more,” he added.

Kaplan cautioned against reading too much into the Fed’s latest dot plot, saying it might not have reflected the US-Iran deal and reopening of shipping routes. The outlook could look different by the time officials release their next set of forecasts in September.

“If I were in my former seat, I would be urging caution about interpreting this dot plot because we just had a big change and I want to give a chance for that to work through the system,” he added.

Warsh also said:

I think financial markets perform best when they react to incoming data. I think the financial markets work less efficiently when they ask a question, ‘How will the Federal Reserve react to that incoming information?’. Financial markets can offer valuable data to central banks—but not when investors are betting primarily on what the central bank itself will do.

Also yesterday:

US Retail Sales Rise in Broad Gain Despite Higher Gas Prices

US consumers ramped up spending in May across a broad range of retailers, signaling households powered ahead despite higher gasoline prices.

The value of retail purchases rose 0.9%, marking a fourth straight month of increases, Census Bureau data showed Wednesday. The figures aren’t adjusted for inflation.

Outside of receipts at gas stations, sales rose a firm 0.7%. (…) So-called control-group sales — which feed into the government’s calculation of gross domestic product — were up 0.7%. That measure excludes food services, auto dealers, building materials stores and gas stations.

“Spending is pretty broad-based. This isn’t a fluke,” said Shruti Mishra, a US economist at Bank of America Corp. “The consumer appears to have made it through the worst of the energy shock relatively unharmed.” (…)

The figures are consistent with card data from Bank of America, JPMorgan Chase & Co. and PNC Financial Services Group, which indicated spending continued to advance last month alongside larger-than-usual tax refunds and a rising stock market. (…)

Spending at restaurants and bars, the only service-sector category in the retail report, fell 0.1% in May after a strong increase in April.

This chart shows how nominal retail sales growth shot through growth in labor income in recent months as my retail inflation proxy jumped from 1.0% YoY to 5.0% in just a few months.

How broad?

The Census Bureau lists 11 retail categories other than motor vehicles and gasoline. The five categories that had growth below the 5.6% average for May grew only 2.0% YoY on average. On a MoM basis, 7 groups had growth below the +0.5% average for a 0.06% MoM growth rate, essentially flat in May.

Street economists may not feel it but Main Street Americans must deal with food inflation of 3.0-3.5% (food-at-home was +4.2% a.r. in April-May) or apparel up 4.8% (+5.5% a.r.) including footwear at +5.2% (+12.0% a.r.).

Inflation on furniture/home furnishings and building materials is tame but only because demand is so weak.

Trump Says Anthropic Negotiations Continue as AI Leaders Huddle at G-7

(…) At the lunch, OpenAI Chief Executive Sam Altman and Demis Hassabis, the head of Google’s DeepMind AI lab, were seated next to Trump. Amodei was seated on the opposite side of the table from the president, next to French President Emmanuel Macron. Down the table were Lutnick and Treasury Secretary Scott Bessent, who were among the officials that targeted the company’s models last week.

The ban on Anthropic models raised concerns among industry executives and foreign governments that unilateral actions by the administration could dictate who can use leading AI models.

Macron told reporters the U.S. made a strong decision that reflects growing awareness that AI can be dangerous. “The bad thing is that the reaction is, in a way, strictly nationalist,” he said, adding that democracies need to cooperate on these issues.

“We won’t buy any models made by these companies if overnight, you can just flip the switch,” Macron said. (…)

At the lunch, Amodei and Hassabis advocated for the U.S. to lead G-7 countries in shaping AI safety standards, people familiar with the meeting said. Others proposed a more decentralized standards-alignment process, similar to that of the Financial Stability Board set up in the wake of the 2008 financial crisis.

Altman called for an international forum to settle on “globally accepted standards for testing” and “impartial analysis” of AI risks, adding that “it is crucial that we do not allow the risks of this technology to lead to undue concentration of power,” according to excerpts of his remarks.

“One thing everyone agreed on is that there does need to be an effort initiated to coordinate among the G-7,” said Aidan Gomez, chief executive of Canadian AI startup Cohere. (…)

One European leader said that the case is becoming compelling for good-enough homegrown tech that costs less than the US version and has fewer strings attached. China must be seeing an opening with its low-low cost open source models.

The FT quotes Arthur Mensch, CEO of French AI company Mistral: “one of the big concerns discussed was how countries could make sure they had a supply chain for AI technology they could control. When you have an intertwined supply chain, are you sure that your counterparts can’t cut you off? That was mentioned multiple times mainly by non-US participants”.

It’s not only LLMs and other software apps, it’s the whole supply chain that’s seen at risk, even among “allies”.

Trump Demanded Iran’s ‘Unconditional Surrender.’ He Got a Surprise Instead.

(…) But it was Mr. Trump himself who offered what may be the most cleareyed answer about why he needed to end this war so fast. He didn’t want comparisons to Herbert Hoover, he told reporters at the Hotel Royal in Évian-les-Bains, on the shores of Lake Geneva, on Wednesday.

“He was always the one I didn’t want to be,” Mr. Trump said of the 31st president, who presided over the market crash that ushered in the Great Depression. “I didn’t want to see economic catastrophe.” Later he noted that if the war continued, the world would have begun to run out of oil stockpiles.

That combination — economic chaos and disrupted oil markets — is exactly what the Iranians viewed from the opening days of the war as their most potent weapon. They executed on that vision with precision, closing the strait and blowing up petrochemical facilities, desalination plants, hotels and air bases across the Gulf. And by the president’s own testimony, it worked.

If that was Phase 1 of Iran’s strategy, history suggests Phase 2 may be one of delay and more delay. In past negotiations, the Iranians refined the art of arguing over every paragraph, throwing in new obstacles to inspections or reinterpreting the meaning of “nuclear research” to embrace continued uranium enrichment. Few were more skilled at this process, former American negotiators say, than Abbas Araghchi, the Iranian foreign minister, and a veteran of past talks.

And Mr. Trump, eager to move on, seems to be paving the way for a long, slow process. On Tuesday, he said he wasn’t especially concerned with getting Iran’s nuclear fuel — now buried under the rubble of last year’s American air attacks — out of the country. On Wednesday, he acknowledged the talks would probably go beyond 60 days. (…)

“The only ‘achievement’ of the ceasefire is the likely re-opening the Strait of Hormuz — which was open before the war started,” former Secretary of State Antony J. Blinken wrote online on Wednesday. “And we will apparently pay Iran to do so, in the form of waivers for the export of Iranian crude oil. Iran has now demonstrated the capacity to stop or slow the passage of oil, natural gas, fertilizer and other critical products upon which so much of the world depend.”

Mr. Blinken, an architect of the 2015 accord, concluded: “Going forward, it will almost certainly find ways to collect ‘fees’ for safe passage that will help entrench the regime.” (…)

But the bigger risk may be this one: When Iran’s leaders begin to clear the rubble left by 40 days of bombing, and think about how to spend the billions in oil revenue that will soon resume, they may well question whether they had the right nuclear strategy. (…)

On Sunday, when Mr. Trump called The Times, this reporter asked him whether Iran might now follow the North Korean model. “He’s got serious nuclear weapons,” Mr. Trump said of Kim Jong-un, whom he threatened with annihilation during the first Trump term, then met three times in a fruitless effort to convince him to disarm. “But that should not have been allowed,” he said, asking whether North Korea got the bomb under President Clinton or President Obama. (It made its first test under President George W. Bush.)

But Mr. Trump evaded the question of whether his decision to attack Iran could ultimately drive it to follow North Korea’s model. And he insisted his deal would stop Iran, saying Prime Minister Benjamin Netanyahu should thank him for keeping Israel from nuclear annihilation.

“Whatever it takes,” he said. “Forty-seven years,” he said, referring to the 1979 Iranian revolution, “nobody was able to do it. And we did it. We did it the right way.”

History may prove him right, but it is far too premature to make that claim. Maybe even he knows that, based on his statements on Wednesday morning. If the accord didn’t stick, he had a plan, he insisted. He would “go back to bombing.”

Like if that plan worked…

NY Fed’s Services Business Survey

 

 

IMPORT PRICES IMPORT

Prices for U.S. imports advanced 1.9% MoM in May following increases of 2.0% in April and 0.9% in March. Prices for U.S. imports rose 6.7% YoY in May, the largest advance since the index increased 7.7% in August 2022.

Prices for nonfuel imports increased 0.8% MoM in May, after +0.6% in April. “In May, higher prices for capital goods; nonfuel industrial supplies and materials; consumer goods, excluding automotives; and automotive vehicles, parts, and engines more than offset lower prices for foods, feeds, and beverages.”

Nonfuel import prices increased 3.7% YoY in May, the largest since the index rose 3.9% in August 2022.

• All imports excluding food and fuels rose 0.9%, +3.7% YoY but +8.0% annualized in the last 4 months.
• Industrial supplies & materials ex-petroleum rose 2.2%, +10.4% YoY but +7.1% annualized in the last 4 months. 
• Capital goods rose 1.3%, +5.6% YoY but +12.8% annualized in the last 4 months.
• Manufacturing rose 0.9%, +4.7% YoY but +11.5% annualized in the last 4 months. 
• Consumer goods, excluding automotives rose 0.2%, +1.7% YoY but +3.3% annualized in the last 4 months.
• Import prices for computer peripherals and parts rose 8.9% MoM and 39.7% YoY.

Import prices from China increased 0.9% in May and rose 1.1% YoY. The increase in May was the largest 1-month advance since the index rose
0.9% in January 2008.

Charts from Ed Yardeni:

Goldman Sachs estimates that “the core PCE price index rose 0.31% in May (unchanged from our expectation prior to today’s import prices report), corresponding to a year-over-year rate of +3.38%. Additionally, we expect that the headline PCE price index increased 0.45% in May, or increased 4.04% from a year earlier.”

Nobody cares about inflation, more so since the apparent cease fire. Will the Fed care?

While on inflation:

“And now what’s happening is the cost of tokens are far higher than the actual value that these tokens are generating at scale. And so what ends up happening, and the big risk in the market is, if you don’t create an equilibrium there, then people just pull back on using tokens, and that’s actually not good for anyone.” – Cisco President Jeetu Patel

China Moves to Boost the Use of Yuan Globally China will launch pilot program for offshore yuan foreign exchange trading

Chinese authorities rolled out more measures to promote the use of the yuan globally, their latest effort to build more resilient financial infrastructure to shield its economy from external shocks.

Pan Gongsheng, head of the People’s Bank of China, announced Wednesday that Beijing will set up a new repo facility. This facility will let foreign monetary authorities, including sovereign-wealth funds, obtain yuan liquidity from the Chinese central bank with bonds as collateral.

He also revealed that China will launch a pilot program for offshore yuan foreign exchange trading in the Shanghai Free Trade Zone, as he spoke to financial executives at Shanghai’s Lujiazui forum on Wednesday. This program is aimed at turning the coastal city into a global hub for yuan-denominated asset allocation and risk management. (…)

AI CORNER

Why Does Trump Hate Anthropic? The de facto ban on its Fable 5 model is a dangerous precedent.

The WSJ Editorial Board:

Which is a greater threat—China or Anthropic? The Trump Administration can’t seem to decide judging from its order to restrict access to Anthropic’s frontier artificial intelligence models. The fallout could undermine America’s AI lead and cyber defenses.

The White House’s simmering feud with Anthropic erupted again last week after the company released its new advanced Fable 5 model. Trump officials have demanded that Anthropic restrict access to its powerful Mythos model over concerns adversaries could exploit its tools for cyber warfare. Fable 5 is Anthropic’s attempt at a compromise.

Fable 5 boasts advanced coding, research, analytic, agentic and other capabilities similar to those of its Mythos model, but it also includes safeguards to prevent its use for cyber. The goal was to provide enterprise customers more powerful tools while assuaging the White House’s concerns that they could be weaponized by bad actors.

At least that was the idea. But on Friday evening the Administration abruptly ordered the company to restrict Fable 5’s access to foreigners after Amazon flagged that users could trick the model into bypassing its cyber safeguards. This is what the industry calls a jailbreak.

The export control amounts to a de facto ban on the model since Anthropic has no way of ascertaining the nationality of its users. Even its U.S. customers employ foreigners. The Administration appears to have overreacted to the Amazon report or used it as a pretext to renew its feud fight with Anthropic.

Trump officials and Anthropic disagree about the seriousness of the jailbreak. (…) Anthropic also stressed it’s probably not possible to build a 100% fail-safe model (…).

President Trump lambasted Anthropic as “some out-of-control, Radical Left AI company,” echoing comments by AI adviser David Sacks, who criticized the company for hiring former Biden officials and supporting “Woke AI.” (…)

Trump officials overlook that it will also impede U.S. AI innovation by setting a precedent that the government can at any moment order a model off the market. (…)

The NYT’s Ross Douthat sees broader consequences (my emphasis):

(…) the battle over Anthropic’s cutting-edge artificial intelligence models, is the beginning of a new kind of conflict, with private powers and national governments struggling to determine who actually rules an A.I.-dominated world. (…)

It’s a conflict rich in ironies. A White House that sees itself as favoring a free-market approach to A.I. has now twice used heavy-handed regulatory weapons against America’s leading A.I. company. (…) Meanwhile Anthropic sees itself as the A.I. company that’s most attuned to safety issues and eager for democratic oversight, but each move from the Trump administration has prompted the company to shout, “No, not like that!”

(…) the kind of conflict we’re seeing here is overdetermined by the trajectory of the A.I. models: There is too much potential power here not to have ongoing, escalating struggles over who actually gets to rule. (…)

There is a path here that leads to nationalization in all but name and a path that leads to a kind of de facto corporate takeover of the government, or at least a too-big-to-fail symbiosis. And along the way there may be not just conflicts between presidents and A.I. executives but also increasingly ruthless corporation-on-corporation action, out of fear that the A.I. landscape is winner-take-all to an extent we’ve never seen in capitalism before. (…)

Then alongside the struggle to control A.I. power within American borders, there is the geopolitical struggle to maximize global power (where the only real players are probably the United States and China) and maintain sovereignty (where everyone else is likely to be scrambling to maintain some independence).

The use of export controls to shut down Fable presumably reflected U.S. fears of Chinese access to a jailbroken version of the model, but it was also a warning to every other country in the world: If we end up with economy-permeating A.I. models that are made and regulated in America, the American government will control the on-off switch.

One possibility for what that means is spun out in “Europe 2031,” a futurist scenario written by European A.I. researchers and investors in which the European Union ends up choosing political and economic vassalage to either the United States or China, because it lacks sufficiently powerful A.I. models that are under its own control. (…)

But at the very least, American and Chinese A.I. dominance is going to create new issues for sovereignty, new forms of dependence and coercion, that will weigh heavily on middle powers as their economies become more and more dependent on specific models and access to computing power. (…)

This “winner-takes-all or almost all” potential of AI is why so many companies are hastily spending so much money. “There is more risk in underspending then in overspending”. Good for economies and investors but, eventually, a few big winners will kill several also big losers.

There is just no way that all that capital deployed will earn a reasonable return. There will be blood.

How to deal with or control the winners’ huge power? “There is a path here that leads to nationalization in all but name”. Yes, and that possibility has immediate consequences.

How do companies/governments justify using a particular LLM model/application if models and their apps can eventually be “nationalized”, controlled or even banned in some ways, shape or forms by governments worried of a loss of sovereignty or regional/global power?

How can investors properly value AI developers if even an assumed free-market government can step in and regulate in ways that can jeopardize the business model?

Holman W. Jenkins, Jr., also in today’s WSJ:

Government vs. AI Profits?

(…) All this will be magnificently beside the point, moreover, if the latest AI models, after billions invested, can’t be released to the public because they’re too dangerous—or if they’re swallowed up in a standardless, jury-rigged licensing system run by the Trump administration.

Suddenly the barriers to America’s AI companies getting paid for their innovations seem daunting. Ditto America maintaining its technology lead.

Blame is dished by some at a chaotic administration, seen as abandoning its pro-innovation “let it rip” attitude. But it’s the CEOs of the leading companies, OpenAI and Anthropic, who’ve told us for years their products were dangerous, who called for prescriptive regulation, not least, some suspect, to lock in their dominance. Be careful what you wish for. (…)

By June 12, the administration was reaching for draconian export controls to prevent a supposedly safer version, known as Fable 5, from being accessed even by Anthropic’s own non-U.S. employees, much less the 96% of the potential market consisting of non-U.S. users. (…)

Experts debate how serious these risks really are but the momentum toward government control is unmistakable. Waiting in the wings is the Defense Production Act of 1950, enabling stringent U.S. authority over industries deemed vital for national defense.

This holds out a troubling prospect: Either AI progress will stop as investors abandon it, or progress will be funded by government, the only user allowed access to cutting-edge models—essentially confiscation by other means.

For small investors, the debate arrives at an inconvenient moment. Never mind whether last week’s SpaceX IPO was really as AI-centric as Mr. Musk claims. On the same day it began trading, the administration imposed its sweeping export ban on Fable 5. (…)

Will SpaceX’s now be the last AI IPO? It isn’t impossible at the rate top-tier developers find themselves caught in an avalanche of national-security attention. OpenAI co-founder Greg Brockman was recently reported to have mused puckishly about the company offering its services to the highest bidder among America’s geopolitical rivals. His impolitic remark is seen now as a dark reflection on the national-security trap AI was about to fall into.

Anthropic founder Dario Amodei warns incessantly about a Chinese AI threat even as his company attracts a trillion-dollar valuation that makes sense only if it will be free to commercialize its innovations rather than see them absorbed into an all-embracing military-cyber-industrial complex.

Hang on. It’s going to be a bumpy ride.

And bloody.

Trump Invokes Cold War-Era Law to Boost Munitions Production Concerns have grown that the U.S. has burned through a lot of weapons during the war with Iran

Great timing, no?