Former Fed Vice Chair: The default option now is to raise interest rates; Warsh's speech reversed the Fed's previous logic

Odaily Planet Daily News "Fed whisperer" Nick Timiraos reported that Fed Chair Warsh has calmed some concerns about his strategy to fight inflation, but has also set the stage for a bigger test that could come three weeks later. If the Fed raises interest rates, it could anger the White House weeks before the midterm elections. If it holds steady, it could reignite the doubts that the speech had eased.

Two points in Warsh's speech on Friday particularly suggest the Fed may raise rates next month. First, Warsh found it difficult to characterize current financial conditions as restrictive. Second, the more favorable inflation data over the summer did not convince him that the underlying trend is improving. Before Friday, the Fed's default option was to hold steady unless the data was strong enough to justify action.

Former Fed Vice Chair Kohn said Warsh's speech reversed that logic. "He has changed the original assumption—now it's that unless the data shows there is no need, they will raise rates." This means the final decision will depend on how the situation evolves before the September meeting, especially the August CPI report due on September 11. Kohn said that if the data suggests no action is needed, the Fed should not raise rates; if the data is strong, it could weaken the argument that inflation is heading back toward the Fed's 2% target. (WSJ)