Analysis: Hot CPI puts Kevin Warsh's Fed credibility on the line before rate decision

Hot CPI puts Warsh’s credibility on the line before rate call: Analysis

Investors are increasingly expecting the Fed to raise interest rates at its Sept. 15-16 meeting after hotter August CPI data. Fed Chairman Warsh has warned that inflation remains above the Fed’s 2% target and that prices should be the central bank’s main focus. Other Fed officials had signaled more willingness to wait unless inflation clearly accelerates. If Warsh does not act, he risks reviving questions about whether he or another figure is driving Fed policy.

Hotter-than-expected inflation data has turned next week's Federal Reserve meeting into a defining test for Chairman Kevin Warsh . His choice now is whether to raise interest rates , or look like he isn't in control of the central bank he leads. Friday's consumer-price index data make the trade-off acute for Warsh. Core consumer prices, which strip out the effects of food and energy prices, rose 0.3% in August, more than expected. Headline inflation rose 0.4% for the month, putting it 3.4% above the level a year ago.

Warsh hasn't promised any particular action on rates, but he recently laid out a case that the Fed will need to raise interest rates if inflation doesn't moderate. He arguably preserved the wiggle room to keep rates flat if he and the rest of the Fed choose not to act at their Sept. 15-16 meeting. But with his leadership of the Fed under intense scrutiny from inside and outside the organization, not acting after his repeated inflation warnings will make it harder for him to convince the market he is serious next time.

Economists will find ways to slice the new CPI data. Warsh's challenge is that his economic philosophy specifically frowns on making quick turns on individual data points such as the latest CPI print. That puts him in contrast with Fed officials such as Governor Christopher Waller and New York Fed President John Williams. Both entered the final stretch before the meeting more inclined to wait for remaining data before deciding whether a rate increase was necessary. Warsh, by contrast, has repeatedly warned against putting too much confidence in short-term forecasts. He said last month at the Kansas City Fed's annual symposium in Jackson Hole, Wyo., "accuracy in forecasting is still just an aspiration" for the Fed.

"Inflation is running above our 2 percent target," Warsh said in an Aug. 28 speech at Jackson Hole. "So the Fed's predominant focus right now should be on prices." Warsh said he was downplaying recent improvements in inflation data in favor of his broader view of underlying inflation, which he said was informed by his reading of the data feeding into the two main price indicators: personal consumption expenditures and the consumer price index.

"While this summer's PCE and CPI readings were better than expected, they do not tell me that underlying trends have meaningfully improved," Warsh said at Jackson Hole . Headline inflation measured by the PCE index is up 3.7% as of the most recent data. Waller, meanwhile, has given a reading of the data much more in keeping the Fed's tradition of data dependence. Inflation may be above 2%, Waller said at a Reuters event on Sept. 3. But "recent data suggests we are finally seeing some signs of disinflation," he continued. "Now, if this continues in the data over the next two weeks, I would be inclined to sup...