US Economic Weekly: July FOMC preview: It’s Warsh’s call

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US Economic Weekly: July FOMC preview: It’s Warsh’s call

…But would Warsh hike in response to oil?

It isn’t an easy choice to hike either. If the Fed hikes in July, the optics could be that the

market forced Warsh’s hand, even though the intra-meeting data were supportive of a

hold. Warsh has also said that the Fed should look through supply shocks and focus on

“underlying inflation”. Hiking in response to oil would contradict this framework. It could

cause markets to reassess their view of Warsh’s reaction function (especially since he

refuses to convey it) and price in a much higher policy path.

Three reasons a hike is highly plausible

We think there are sound arguments for responding to the oil shock (though to be clear,

Warsh hasn’t embraced them). For one, volatility in oil alone arguably creates upside

risks to the core. Firms that pass through cost increases when oil surges might be less

willing to lower their prices when oil declines, due to concerns that there will be another

upside shock in short order. Indeed, it appears quite likely that airfares won’t retrace

their surge at the start of the conflict anytime soon.

For another, as we argued back in March, $80-100 is likely the most hawkish outcome

for crude (Exhibit 2). It’s a large enough shock to create upside risks to core, but not so

large that the Fed would worry about major downside risks to the labor market. Each

bout of escalation increases the probability that we will land in this range, on average, in

the next few quarters.

We also see strategic incentives for Warsh to push for a hike. There is a narrow window

(say, a few months) in which he can absolve himself of any blame for the inflation

overshoot. Hiking in that period would differentiate him from Powell and allow him to