September's CPI data rebounded more than expected, reigniting market concerns. Coupled with a stronger-than-expected PPI, before Warsh's speech, the market was speculating whether sticky inflation would return and whether the Fed would resume interest rate hikes at its October meeting. However, in his dialogue at the IMF annual meeting in Bangkok, Fed Chairman Warsh avoided a strong stance and almost entirely avoided the topic of inflation. This "silence," however, calmed the tense financial markets. Why? Behind this event lies the core contradiction in the US today: the bond market is betting on a moderate decline in inflation, while ordinary consumers feel prices remain high—two sets of inflation expectations are severely disconnected.

Inflation expectations are polarized: the bond market is optimistic, but the public feels the complete opposite.

Today's focus is on the TIPS breakeven inflation rate (BEI), representing bond investors' implied inflation expectations. In my previous articles, I often analyzed nominal interest rates and TIPS rates, with BEI serving as the bridge: Nominal Interest Rate = TIPS Rate + BEI. I prefer to write BEI as Inflation Expectation + IRP (Inflation Risk Premium) - TIPS Liquidity Premium. Currently, the market prices an average inflation rate (BEI) of approximately 2.34% over the next 10 years and 2.36% over the next 5 years, with optimistic expectations that inflation will steadily return to the Fed's 2% target. This expectation is even lower than the average inflation levels of 3.35% over the past 10 years and 2.55% over the past 30 years. However, consumers' perceptions are entirely different. A New York Fed survey shows that the public expects inflation to be 3.9% over the next year and 3.3% over the next three years. On one hand, the bond market is "hoping to overcome reality," while on the other hand, ordinary people continue to bear the pressure of rising prices. "Affordability" has become a hot topic in society. Recent inflation data does not support optimistic assumptions for the bond market: September CPI rose 3.7% year-on-year, higher than August's 3.4%, mainly due to rising fuel prices; core CPI rose 2.6% year-on-year; PPI rose 6.3% year-on-year, and core PPI rose 5.0% year-on-year. The market expects September PCE to rise 3.6% year-on-year and core PCE to rise 3.2% year-on-year, both higher than August's figures. If core PCE reaches 3.2%, it will be the strongest monthly annualized increase since 1992, excluding the impact of the pandemic. Since the spring of 2021, inflation has been above the 2% target for five and a half years. Geopolitical conflicts, trade barriers, and supply chain disruptions have occurred one after another. Historically, policymakers have been accustomed to attributing each round of price increases to "one-off shocks," just as they attributed food inflation in the 1970s to reduced anchovy production in South America. However, when one-off events occur repeatedly, it indicates that the era of low-friction globalization is over, and the inflation center may be permanently raised. Other institutions point out that the current federal funds rate is below 4%, and nominal GDP growth exceeds 6% year-on-year, indicating a still relatively loose policy environment, which is the underlying reason why inflation is difficult to fall quickly. Of course, the TIPS breakeven inflation rate (BEI) itself has technical flaws. TIPS liquidity is far lower than that of ordinary nominal Treasury bonds, and the liquidity premium pushes up TIPS yields, suppressing the breakeven inflation reading. Therefore, inflation expectations in the bond market are inherently underestimated. Academic research also suggests that public inflation expectations are rooted in personal experience, not simply anchored by central bank pronouncements; the Federal Reserve's credibility can ultimately only be demonstrated through real inflation data, not verbal promises.

Walsh's speech in Bangkok: What really matters is what he didn't say.

Immediately after the CPI data impacted the market, the probability of an October rate hike increased significantly, with CME FedWatch briefly showing a near 28% probability, and S&P 500 futures turning negative during the session. The market was awaiting hawkish signals from Warsh to confirm that the rebound in inflation would force the Fed to raise rates again. However, in his half-hour conversation with IMF Managing Director Georgieva in Bangkok, Warsh barely discussed the recent rebound in inflation. He only mentioned that since the September policy meeting, the global economy has largely met the Fed's expectations. He clearly stated: "I will not predict the outcome of the policy meeting, and I do not intend to reveal the policy actions that may be taken at the remaining meetings this year. The Fed has turned a new page and will no longer provide forward guidance." This statement directly reversed market pricing, with the CME FedWatch's probability of an October rate hike quickly falling back to 15%, and S&P 500 futures rebounding by 0.2%. Deutsche Bank analyst Jim Reid commented: "The most important thing is precisely what he didn't say." Warsh did not intervene to suppress market interest rate expectations, and this lack of hawkish rhetoric was interpreted by the market as a positive sign. Since taking office in May of this year, Warsh has proactively abandoned the traditional forward guidance framework. His new approach to policy communication emphasizes that the market should focus on the economic data itself, rather than the rhetoric of Federal Reserve officials. He no longer "spoils" the policy path for the market in advance, thus maintaining uncertainty in the decisions of each FOMC meeting.

Key takeaways: The central bank focuses on actions, not rhetoric; simultaneously, there is a discrepancy in bond pricing.

The saying "actions speak louder than words" aptly summarizes the current situation. Warsh didn't issue any dovish promises this time, but rather refused to proactively issue hawkish warnings. This new "less talk, more data" approach shifts the pressure to subsequent inflation data. If PCE and CPI continue to rise, even with Warsh's dovish remarks, the Fed still has the option to raise interest rates; conversely, if inflation gradually cools, the rate hike cycle will likely end. A deeper contradiction remains unresolved: the bond market, based on TIPS pricing, is betting on inflation returning to 2%; ordinary people, based on their daily consumption experience, believe inflation will remain high. Whether the bond market's optimistic expectations can be realized depends on whether the current high inflation is a series of temporary shocks or has entered a new medium- to long-term trend above the target. Warsh's choice to remain silent essentially leaves the answer to a series of future inflation data. Meanwhile, how the difference between the bond market's perception and the public's actual experience will be addressed in the future is also a key point to observe.