Warsh turns hawkish, but Nomura still expects cooling inflation to keep the Fed on hold

Overview

This US Economic Weekly focuses on Warsh's hawkish remarks at Jackson Hole, the August employment outlook, accelerating capital expenditure, and an upward revision to the GDP tracking estimate. Nomura believes that the US labor market and private demand remain robust and that weakening inflation momentum is still sufficient to support unchanged Federal Reserve policy, but policy is highly sensitive to near-term inflation data, and any obstruction to disinflation could reopen the door to rate hikes.

Core views

First, the report views Federal Reserve Chair Warsh's Jackson Hole speech as distinctly hawkish. He reiterated that the Federal Reserve targets PCE inflation and suggested that policy might need to act if disinflation does not occur “rapidly.” He played down the dovish implications of recent moderate inflation data and slowing wage growth, saying he was not yet convinced that inflation trends had improved. Although market inflation expectations remain generally stable, he warned that such indicators often appear well anchored until they become destabilized. Warsh adopted an inflation diffusion perspective, noting that although the share of PCE components with annualized increases above 3% over the past six months is far below its post-pandemic peak, it remains elevated; this indicator cannot be updated with August data before the September FOMC meeting. He also placed greater emphasis on robust growth in private domestic final demand, viewing it as a better gauge of economic conditions than GDP, and interpreted recent hiring weakness and low labor mobility as a post-pandemic recovery reversal rather than a sign of labor-market fragility. Warsh also toned down his previous optimism about future disinflation. Although he discussed artificial intelligence and productivity growth, he no longer suggested that these factors would suppress inflation over the long term and also played down his criticism of official statistics. The report believes the speech did not directly signal an imminent rate hike, and moderate inflation data may still be sufficient to keep policy unchanged. However, Warsh has moved closer to the position of most FOMC centrists: rates may need to rise if disinflation stalls. The report therefore concludes that near-term inflation data have become significantly more influential for the policy path. On employment, Nomura expects nonfarm payrolls to increase by 60k in August, reversing July's unexpected contraction, with private-sector employment expected to rise by 45k. The sharp summer decline in local government education employment in July is expected to partially reverse. Evidence supporting this view includes initial jobless claims remaining near post-pandemic lows, weekly ADP employment stabilizing, survey indicators showing that businesses are adding staff, the S&P services PMI employment index rising to its highest level since January 2025, and Nomura's expectation that the ISM services employment index will return to expansionary territory. The report expects the unemployment rate to fall to 4.0% in August, its lowest level since January 2025. Layoff indicators remain subdued, while the Conference Board's labor market differential rose in August to a four-month high of 7.5. Nomura expects JOLTS job openings to rise from 7.359mn in June to 7.4mn in July, the ratio of job openings to unemployed workers to increase from 1.04 to 1.07, and the job openings rate to rise from 4.4% to 4.5%. The expiration of Temporary Protected Status for Haitian asylum seekers poses a downside risk to near-term labor supply. Nomura expects average hourly earnings growth to rebound from July's unusually weak level to 0.4% m-o-m in August, partly due to a calendar effect during the month. However, other wage indicators have softened recently and leading indicators have also stabilized, so the report believes underlying wage growth continues to slow gradually. The preliminary nonfarm payroll benchmark revision is estimated at -79k jobs, equivalent to about 7k fewer jobs created per month over the 12 months through March 2026. Although unexpectedly weak, this revision remains moderate compared with the large negative revisions that prompted markets to reassess employment conditions in previous years. It is insufficient to change the broader narrative of a healthy labor market and instead would keep the Federal Reserve focused on inflation risks. Capital expenditure is another major theme. Core capital goods shipments rose 1.4% m-o-m in July, above Nomura's 0.6% forecast and the market consensus of 1.0%; June growth was also revised up by 40 basis points to 2.4%. Three-month average growth in core shipments reached its fastest pace since January 2022, with strength relatively broad-based. The advance goods trade report showed the largest monthly increase in capital goods imports in the history of the series. Trading-partner data also indicate that technology-related imports could accelerate further in the coming months. The report therefore concludes that business investment remains strong and is broadening beyond artificial intelligence-related investment. Driven by stronger-than-expected personal consumption in July, trade and durable goods orders pointing to stronger business investment, and wholesale and retail inventories exceeding forecasts, Nomura raised its third-quarter GDP tracking estimate from 2.7% last week to 3.6%, both at seasonally adjusted annualized quarter-on-quarter rates. The tracking estimate for real final sales to private domestic purchasers was raised from 1.7% to 2.8%. Over the medium term, the report believes growth will remain supported by strong business investment and resilient consumption. Consumption accelerated in the second quarter due to higher tax refunds, income growth, and temporary factors, and some payback may occur in the third quarter, but a moderate slowdown is more likely than a severe deterioration. Higher mortgage rates continue to restrain housing activity, while the unemployment rate is expected to decline gradually to 3.9% by the end of 2027. On inflation, core inflation remains significantly above the Federal Reserve's 2% target, but the report expects it to decelerate gradually in the second half of 2026 as tariff pressures ease, crude oil prices decline, residual seasonality fades, and wage growth slows. Nomura forecasts core PCE inflation of 3.3% y-o-y in the fourth quarter of 2026; the BEA's planned methodological adjustment could lower this reading by about 20 basis points to 3.1%. Risks remain tilted to the upside. The artificial intelligence investment boom could generate stronger price pressures, while an AI-driven memory-chip shortage or supply-chain disruptions caused by a prolonged war with Iran could trigger a second round of goods inflation. The policy baseline is for the Federal Reserve to maintain its current stance indefinitely. Although inflation remains elevated, weakening inflation momentum, Warsh's prior dovish inclination, and most officials' preference for a wait-and-see approach all support inaction for now. Moderate core PCE readings and potential downward revisions would also help sustain this stance. However, the report clearly believes that risks are tilted toward tightening: if the Federal Reserve waits too long to respond to incipient inflation pressures, it could fall behind the curve; market concerns about its inflation-fighting credibility could also force it to rebuild credibility through rate hikes. The report does not expect Republicans to enact another budget reconciliation package delivering large-scale fiscal stimulus before the midterm elections. The forecasts for the coming week broadly continue the theme of “resilient growth, with inflation determining policy.” Nomura expects the ISM manufacturing index to fall from 55.6 to 54.8 in August, with new orders and output slowing but remaining in expansionary territory; auto sales to edge down from an annualized 16.3mn units in July to 16.2mn; the ISM services index to rise from 54.1 to 54.5; and the July trade deficit to widen from $73.3bn to $99.0bn. The Beige Book's overall assessment of economic activity may be revised slightly lower because consumption slowed after accelerating in the second quarter and the temporary boost from the World Cup has faded, although business investment remains resilient.

Analysis framework

The report first interprets changes in Warsh's speech regarding the inflation target, assessment of the data, and policy reaction function, then cross-validates its August employment forecast using multiple indicators, including jobless claims, ADP, PMI, JOLTS, layoffs, and wages. It subsequently updates its GDP tracking estimate by combining core capital goods shipments, capital goods imports, trading-partner data, consumption, and inventory information. Finally, it incorporates its growth, employment, and inflation assessments into the Federal Reserve's baseline policy scenario and risk scenarios and provides forecasts for the major economic data releases in the following week.

Methodology notes

• Macroeconomic framework

  PCE inflation diffusion indicator

  Warsh focuses on the share of PCE components with annualized increases above 3% over the past six months, rather than only the headline or core index. This method is used to determine whether price pressures are widespread and supports his cautious stance toward recent moderate inflation readings.

• Industry/sector analysis frameworkSupply-demand framework

  Cross-validation of labor supply and demand

  The report treats job openings, hiring surveys, and ADP data as labor-demand indicators, while using the unemployment rate, jobless claims, and the expiration of Temporary Protected Status as indicators of labor supply or employment conditions to assess whether the labor market remains healthy.

• Macroeconomic framework

  Real-time GDP tracking

  The report continuously updates its estimates of current-quarter GDP and private domestic final sales based on newly released consumption, trade, durable goods orders, and inventory data, using high-frequency data to gauge changes in economic growth relative to the previous week's assessment.

• Industry/sector analysis frameworkUpstream-midstream-downstream value-chain transmission

  Leading information from trading-partner exports

  The report uses trading-partner data to assess the future trajectory of US technology-related imports and combines it with capital goods imports and shipments to evaluate the strength of business investment over the coming months.

Key data

• August nonfarm payroll forecast+60kExpected to rebound from July's unexpected contraction
• August private-sector employment forecast+45kEmployment growth is expected to recover
• August unemployment rate forecast4.0%Expected to fall to its lowest level since January 2025
• August average hourly earnings forecast+0.4% m-o-mPartly supported by a favorable calendar effect
• July JOLTS job openings forecast7.4mn7.359mn in June
• Forecast ratio of job openings to unemployed workers1.07Previously 1.04
• Preliminary estimate of nonfarm benchmark revision-79kEquivalent to about 7k fewer jobs created per month over the 12 months through March 2026
• July core capital goods shipments+1.4% m-o-mAbove Nomura's 0.6% forecast and the market consensus of 1.0%
• June core capital goods shipments+2.4% m-o-mRevised up by 40bp
• Third-quarter GDP tracking estimate3.6% q-o-q arRaised from 2.7% last week
• Tracking estimate for real final sales to private domestic purchasers2.8% q-o-q arPreviously 1.7%
• Fourth-quarter 2026 core PCE forecast3.3% y-o-yBEA methodological adjustment could lower it by about 20bp to 3.1%
• August ISM manufacturing index forecast54.855.6 in July; expected to remain in expansionary territory
• August ISM services index forecast54.554.1 in July
• July trade deficit forecast$99.0bn$73.3bn in June
• August auto sales forecast16.2mn saar16.3mn saar in July

Impact & implications

The report's combined assessment is that the US economy has not shown enough weakness to force the Federal Reserve toward easing: healthy employment, broader capital expenditure, and the upgraded GDP tracking estimate will keep officials focused on inflation. As long as core PCE remains moderate, policy can remain unchanged. If inflation diffusion, artificial intelligence investment, or supply-chain shocks impede disinflation, the Federal Reserve's reaction function will become more hawkish, increasing the risks of rate hikes and sharp market reactions.

Risks

• A lack of forward guidance, insufficient clarity in Warsh's remarks, and renewed political pressure on FOMC members could damage the Federal Reserve's inflation-fighting credibility and trigger sharp market reactions.
• A further escalation in geopolitical tensions could tighten financial conditions and worsen the fiscal outlook.
• If the artificial intelligence investment boom collapses, it could cause a significant adjustment in asset prices and weaken business investment.
• An AI-driven memory-chip shortage could create stronger price pressures and trigger a second round of goods inflation.
• Supply-chain disruptions caused by a prolonged war with Iran could reignite goods inflation.
• The expiration of Temporary Protected Status for Haitian asylum seekers poses a downside risk to near-term US labor supply.
• A sustained artificial intelligence investment boom could push inflation above the report's baseline forecast.

What to watch

• Monitor near-term core PCE and other inflation data, as the report believes Federal Reserve policy is highly sensitive to the pace of disinflation.
• Monitor whether August nonfarm payrolls, the unemployment rate, and average hourly earnings meet the forecasts of +60k, 4.0%, and +0.4% m-o-m.
• Monitor whether July JOLTS job openings, the ratio of job openings to unemployed workers, and the job openings rate continue to rise.
• Monitor the ISM manufacturing and services indices, particularly the employment, new orders, production, and supplier deliveries components.
• Monitor whether capital goods imports, core capital goods shipments, and trading-partner data continue to confirm accelerating technology-related investment and broader capital expenditure.
• Monitor whether the Beige Book downgrades its assessment of economic activity and whether slowing consumption remains merely a moderate payback after second-quarter strength.
• Monitor the potential approximately 20bp downward revision to the fourth-quarter 2026 core PCE forecast resulting from the BEA methodological adjustment.