By Michael O’Neill

The one thing you can say about Kevin Warsh’s Fed is that when it comes to words in an FOMC statement, he’s a remarkably stingy fellow. Today’s statement needed just 131 words to tell investors the Fed left interest rates unchanged at 3.75%. His immediate predecessors usually needed around 750 words to deliver the same message.

That shouldn’t have surprised anyone. Warsh has long railed against forward guidance, arguing policymakers should “stop talking so much. More thinking, less talking.”

The 9-3 vote itself wasn’t much of a surprise either. Inflation remains sticky, growth is holding up and Fed funds futures assign only about a 61% probability of a September rate increase to 4.00%.

While Warsh was busy saying less, the Middle East was saying a whole lot more.

Boom, Boom, Out Go the Lights

Mr. Warsh may be a fan of “less is more,” but that’s not how the US Central Command (CENTCOM) flies.

American and Saudi warplanes struck Iranian-backed militias in Iraq after Trump promised “We are going to beat the f**king sh*t out of them,” following Tehran’s attack on US military bases in Jordan. In less than 48 hours, the conflict has expanded beyond the Persian Gulf into Iraq, Lebanon and Saudi Arabia, shattering any lingering hope that the ceasefire would work.

The Fed may have said almost nothing, but oil had plenty to say.

WTI crude surged nearly 7% lifting July’s gain above 20%. This isn’t just a little geopolitical uncertainty, it’s concern about a full-fledged, boots-on-the-ground invasion. And news that China is sending around 400 shoulder-launched air defence missile launchers suggests the US may find itself in an Operation Iraqi Freedom style conflict (2003-2011) rather than Operation Desert Storm (42 days).

Crude Inflation

Iran’s demonstrated ability to thoroughly disrupt the Middle East supply chain for crude and container shipping in the Strait of Hormuz and the Red Sea complicates the Fed’s ability to manage inflation, maintain full employment and keep the economy humming.

Mr. Warsh has committed to achieving the Fed’s 2.0% inflation target and today’s FOMC result just bought them six more weeks of runway.

Four key inflation reports will shape the narrative before the September 16-17 FOMC meeting. July CPI on August 12 will reveal whether higher oil prices are beginning to spill into broader inflation, while July PPI the following day will show how much of those costs producers are absorbing. Core PCE arrives on August 28 alongside the Q2 GDP price revision. Finally, August CPI on September 11 lands just days before the meeting, giving policymakers one last look at inflation before they decide whether to pull the trigger.

Mr. Warsh will look at alternative inflation gauges as well. He has repeatedly argued that trimmed and median inflation measures provide a better read on underlying price pressures because they filter out temporary shocks such as tariffs, supply disruptions and commodity spikes.

Markets react the moment inflation numbers hit the screen. Warsh can’t. He will wait to see whether the trimmed and median data confirm the headline or dismiss it as noise. If oil sends only headline inflation higher, he has cover to hold. If underlying inflation accelerates as well, the case for a September hike becomes much harder to ignore.

Tiff Has an Oil Problem Too

Bank of Canada Governor Tiff Macklem suddenly has a problem as well. When policymakers left the overnight rate unchanged at 2.25% on July 15, they argued they could largely ignore higher oil prices because there was little evidence they were spilling into broader inflation. That was a perfectly reasonable assumption when crude was oscillating between $75.00 and $80.00 a barrel.

A 7.5% rally since the meeting date, driven by an expanding regional war, is another matter entirely.

If crude stays elevated, the Bank’s comfortable assumption that higher energy prices are temporary could unravel rather quickly. Looking through inflation becomes a lot harder when consumers are paying more to fill the tank and businesses are paying more to move goods. Fortunately, with the BoC inflation gauges, CPI-trim and CPI-median, at 1.8% and 1.9% respectively, inflation is not an issue in the near term.

Give and Take

The Canadian dollar is being pulled in opposite directions. Rising geopolitical risks favour safe-haven demand for USDCAD but gains are hampered by higher oil prices. Even so, the US and Iran drama has a habit of burning brightly then going dark just as quickly. That leaves the outlook for Fed monetary policy to drive direction, the same as it has been doing all year.

Today, the bombs are speaking louder than the Fed.