Fed Chairman Kevin Warsh Leaves the Door Open for September Rate Hike in Jackson Hole Speech

Federal Reserve Chairman Kevin Warsh left the door open to a possible interest rate hike this fall in his highly anticipated speech in Jackson Hole, WY, on Friday, saying the central bank will have "work to do" if inflation doesn't fall soon.

Warsh, speaking for the first time as chairman at the Kansas City Fed's annual economic policy symposium, laid out his vision for a Fed that offers less forward guidance but holds firm to its dual mandate of maintaining price stability and maximum employment.

The central banker said that members of the rate-setting Federal Open Market Committee agree: "Labor markets were stable, and output was solid. But inflation remained too high."

The Fed uses higher interest rates to fight inflation, and lower rates to stimulate the job market. At last month's FOMC meeting, the majority voted to leave the benchmark rate unchanged at a top range of 3.75%, where it has stood since December. But three members dissented and voted for an increase.

The Fed targets 2% inflation as measured by the PCE index, which came in at 3.7% in July. In his comments on Friday, Warsh warned that the Fed would act if that number doesn't come down.

"We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That's our job, our mandate, and our charge to keep," he said.

Financial markets reacted by adjusting the odds of a September rate hike upward. Bond markets put the probability of a September rate hike at 57% after the speech, up from just 35% a day earlier, according to CME FedWatch.

"The question is not if the Fed hikes, but when," says Realtor.com® senior economist Jake Krimmel. "If Warsh wanted to make a threat that markets believe, he succeeded."

Krimmel says that for the housing market, Warsh's stance likely means "some more short-term pain for long-term gain."

"Warsh is right about the threat inflation poses to consumers and, by extension, to housing. Higher inflation means higher mortgage rates for longer, while simultaneously eroding paychecks and real income growth," the economist says. "That hits housing on both the demand and affordability fronts—not to mention the effect of inflation on building materials."

The Fed doesn't set mortgage rates directly, but rather controls the short-term interest rates for overnight lending between commercial banks. However, mortgage rates do move based on investor expectations about inflation and future monetary policy.

"In the short run, I would not predict any real mortgage rate relief this fall," says Krimmel. "But taming inflation as soon as possible can put the housing market in a much better place—on mortgage rates and on purchasing power—in the next six to 12 months, and beyond."

Warsh acknowledges housing market pain

In his speech, Warsh acknowledged the impact that higher mortgage rates are having on the housing market, which has suffered through three straight years of multidecade lows in home sales.

"Certain sectors—like housing and agriculture—are showing strains," said Warsh. "But, on balance, I would be hard pressed to describe broad financial conditions as restrictive."

In other words, the Fed chairman sees the overall economy as thriving under current interest rate conditions, while admitting that housing is a special case.

For prospective homebuyers, this admission may come as cold comfort. But Warsh made clear that the Fed's mandate is to respond to overall conditions in the economy, rather than to tailor interest rates to boost a specific sector, such as housing.

"Sound monetary policy helps households and businesses to prosper," he said. "When carried out effectively, it broadens and deepens the momentum of our economy ... and helps to secure America’s leadership in the world."