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The Fed's family fight over inflation
The Fed's decision last Wednesday to leave rates unchanged initially seemed at odds with what sounded like a fairly hawkish message. But Joe Kalish, chief macro strategist at Ned Davis Research, argues that holding steady wasn't a policy mistake. Most economists expected the Fed to remain on hold, and the data largely supported that outcome.
In a note published Tuesday, Kalish said Chair Kevin Warsh's press conference initially seemed confusing. After revisiting it, however, he concluded the meeting was less about near-term policy tactics and more about a deeper debate within the Fed over economic philosophy.
At the heart of this family fight is a simple question: What really drives underlying inflation?
According to Kalish, Warsh is taking a broader view than traditional inflation measures suggest. He has repeatedly highlighted the role of artificial intelligence and productivity, which Kalish interprets as a focus on unit labor costs.
"Nothing seems more fundamental to underlying inflation and second-round effects than unit labor costs," Kalish wrote.
His framework is straightforward. If compensation growth exceeds productivity growth by enough to push inflation above the Fed's 2% target, policy should tighten. But the data do not currently point in that direction. Kalish notes that the trend in nonfarm unit labor costs was running at 1.6% as of the first quarter, well below levels seen during the inflation surge of 2021-22. Core PCE inflation, meanwhile, accelerated to 3.3% in the second quarter.
The takeaway, in Kalish's view, is that Warsh, Fed governors and New York Fed President John Williams aren't in a hurry to raise rates. As a result, Kalish believes a September hike no longer appears imminent.
That doesn't mean the Fed can relax. Kalish cautions that policymakers will still need to monitor incoming data closely from a risk-management perspective. As he put it, Warsh doesn't want "a revolt on his hands."
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