Analysis: Markets heard a dovish Kevin Warsh. The Fed chairman's own words suggest a rate hike

Investors interpreted Kevin Warsh’s second Fed press conference as dovish, sending long-term Treasury yields rising. Warsh fumbled the message he likely intended to deliver to markets as he pivoted from his clearer prepared remarks to his much-maligned press conference. Warsh’s prepared remarks were more hawkish, stressing that the Fed’s inflation target remains a strict 2%. If upcoming inflation reports stay hot, Warsh may have laid the groundwork for a rate hike at the next FOMC meeting.

The overwhelming response to Federal Reserve Chairman Kevin Warsh’s comments on Wednesday was that he would go easy on inflation. Investors who drove up bond yields in response should be careful. Looking closely at what he said, Warsh may not be as dovish as widely believed. If inflation continues to come in above target, then Warsh — judging by his own words — may feel compelled to act soon to restrain the economy. Investors who act on what they thought they heard risk being blindsided if a rate increase is around the corner.

Crucially, Warsh opted not to celebrate a soft inflation print that had come in prior to the meeting. Had he wanted to present a dovish message, he could have seized on that data. Instead, he wrote it off.

Warsh's muddled performance Wednesday at his second press conference scrambled many investors' view of the Federal Reserve. Some saw a man who had been long perceived as an inflation hawk appear to talk down worries about inflation. He answered reporters' questions with vague statements and left many confused. Some concluded Warsh is in thrall to President Donald Trump, who continues to ask the Fed for lower interest rates, despite the central bank's statutory independence and pledges from both the president and Warsh that independence remains. A chorus of market analysts said Warsh performance called his credibility into question. Long-term treasury yields rose, while the dollar fell and gold rose.

But if the market is misreading the Fed chairman as a dove, it could be in for further violent moves when traders are forced to unwind their positions. It helps to look at the prepared statement Warsh read out at the beginning of the press conference that reflected the message he went into the room intending to send — rather than what emerged from the back-and-forth with reporters.

Ahead of the meeting, the consumer price index showed a rare decline, with prices falling by 0.4% in June from the month before. Warsh was muted on that point. "We understand that the five-plus years of inflation above target cannot be cured in nine weeks — or by a single month of modest price decreases," he said Wednesday, speaking for the Federal Open Market Committee, which sets the Fed's benchmark interest rate.

The words of Fed chairs are among the most carefully parsed remarks in the world. Warsh's performance Wednesday shows he hasn't yet figured out how to rhetorically separate the short-term and long-term challenges. Nor did his exchanges with reporters bolster his prepared remarks. Instead, he undermined himself and his carefully crafted message. Investors were hoping to hear a chairman who would strike a hasty blow against fast-rising pri...