Fed Poised for First Rate Hike Since 2023 under
Kevin Warsh New Chairman, Trump Objects
The Federal Reserve is expected to raise
interest rates on Wednesday, putting Kevin M. Warsh, the chairman, at odds with
the administration just before the midterms.
·
Expected 25-basis-point hike: The U.S.
Federal Reserve is expected to raise its policy rate by 0.25 percentage
point, from 3.50% to 3.75%, at Wednesday’s meeting.
·
First hike since July 2023: This
would be the first U.S. rate increase in more than three years,
reversing the recent easing cycle.
·
Inflation remains above target: U.S.
inflation has remained above the Fed’s 2% target for five years, with
August data showing only limited improvement.
·
Major test for Kevin Warsh: The
decision represents a crucial credibility test for Fed Chair Kevin M. Warsh,
who had strongly criticized the Fed's earlier handling of inflation.
·
Defying Trump: A rate increase would directly
conflict with President Donald Trump’s repeated demand for lower interest
rates to support economic growth, reduce borrowing costs and lower the
government’s interest burden.
·
Political timing: The hike
would come less than two months before the U.S. midterm elections,
making the decision politically sensitive for the Trump administration.
·
Trump–Fed tensions: Trump
has previously pressured former Fed Chair Jerome Powell to cut rates and
his administration subsequently opened a criminal investigation into Powell.
·
Warsh's inflation stance: Since
becoming chair, Warsh has emphasized the need to defeat persistent inflation,
making it difficult for him to suddenly adopt a softer policy without damaging
his credibility.
·
Iran war changed outlook: When
Trump nominated Warsh in January, markets expected rate cuts. By May, the
outlook had changed significantly as the U.S. war with Iran disrupted the
inflation outlook.
·
Fed officials divided: New York
Fed President John Williams has shown limited urgency for a rate
increase, while Governor Christopher Waller has questioned whether
higher rates are necessary if inflation is expected to cool.
·
August inflation tipped the balance: The
latest inflation data showed insufficient progress toward the 2% target,
strengthening expectations that the Fed will raise rates.
·
Possible beginning of a series:
Economists are debating whether Wednesday’s hike will be a one-off move or
the beginning of another tightening cycle.
·
Potential further hikes: The
Fed's updated projections could indicate another 25-basis-point increase in
December, with additional increases potentially projected for 2027.
·
Different possible objectives: A single
hike could be intended primarily as risk management—preventing inflation
expectations from becoming entrenched—rather than signalling an aggressive
tightening campaign.
·
Bond-market pressure: U.S.
10-year Treasury yields have already climbed to around 5%, a multiyear
high. Failure by Warsh to deliver the expected hike could further undermine his
credibility and trigger another bond-market sell-off.
·
Risk of overtightening:
Conversely, excessive rate increases could raise borrowing costs, weaken
employment and slow economic growth.
·
Dot plot significance: The
Fed's updated dot plot will be closely watched for clues about future
rate increases. It could show another hike this year, most likely in December.
·
Administration's affordability agenda: Lower
borrowing costs have become increasingly important to the Trump administration
ahead of the midterms. Treasury Secretary Scott Bessent has already
attempted several measures to push borrowing costs lower.
·
Possible paradox for Trump: A
credible anti-inflation stance by the Fed could actually help reduce long-term
Treasury yields, potentially supporting the administration's objective of
lowering government borrowing costs.
·
Bottom line: The expected hike puts Warsh
between Trump’s demand for cheaper money and the Fed’s mandate to control
inflation. The immediate 25-basis-point increase may be modest, but the
bigger question is whether it marks the beginning of a new U.S.
monetary-tightening cycle.
Days
before President Trump named Kevin M. Warsh as his pick to run the Federal
Reserve, he griped about his past experience picking the leader of the central
bank.
“They’re
saying everything I want to hear,” he told attendees at the World Economic
Forum’s annual gathering in Davos, Switzerland in late January. “They get the
job, and all of a sudden, ‘Let’s raise rates a little bit.’”
Four
months in, Mr. Warsh is on the cusp of doing exactly that. The Fed is expected
to raise interest rates by a quarter of a percentage point on Wednesday, as it
tries to stamp out inflation that has overshot the central bank’s 2 percent
target for five years. It would be the first increase since July 2023.
Raising
rates from the current 3.5 percent to 3.75 percent level would directly defy
Mr. Trump less than two months before midterm elections that will determine
whether Republicans retain control of Congress.
Mr.
Trump has long pressured the Fed to lower borrowing costs to boost economic
growth and make interest payments on the national debt less costly. He
repeatedly demanded this of Jerome H. Powell, whom the president elevated to
chair in his first term. Mr. Trump’s Justice Department later opened a criminal
investigation into Mr. Powell when he did not comply.
This
week’s decision has morphed into a litmus test for Mr. Warsh, who had been
staunchly critical of the central bank’s handling of inflation before taking
the helm. As chairman, he vowed to vanquish it once and for all.
Now
faced with an economy on solid footing, unemployment low and price pressures
barely abating, Mr. Warsh and his colleagues on the policy-making committee
appear boxed in to raising rates. Financial markets see an increase this week
as all but guaranteed, driven in large part by Mr. Warsh’s own tough talk,
which he delivered as recently as last month at the Fed’s annual conference in
Jackson, Wyo.
Failing
to follow through now risks eroding Mr. Warsh’s credibility and exacerbating a
sell-off in U.S. government bonds that has already pushed yields on 10-year
Treasuries this week to a multiyear high of 5 percent.
“He
signed up for the job,” said Ellen Meade, who was a senior adviser to the Fed’s
board of governors until 2021 and is now at Duke University. “He has to decide
what’s important to him — his legacy as Fed chair or getting the approval of
the administration.”
From Rate Cuts to Rate
Hikes
When
Mr. Trump tapped Mr. Warsh for the job in January, the Fed was considered more
likely to lower rates than anything else. By May, when Mr. Warsh was officially
sworn in, those prospects had evaporated. The culprit was Mr. Trump’s war with
Iran, which upended the inflation outlook.
Expectations
about the Fed’s appetite to raise rates firmed after Mr. Warsh decided to begin
his tenure with a steely message on inflation. Markets were left guessing where
exactly the new chairman stood in subsequent weeks, however.
Part
of that was by design, with Mr. Warsh eschewing the typical kind of guidance
that previous Fed leaders had given. But it also reflected the mixed signals
the chairman inadvertently sent at the July meeting about how the Fed would
achieve its goals. That forced him to reset the narrative during his Jackson
Hole address.
Mr.
Warsh, in ceding so much ground to markets to fill in the gaps about where the
Fed is headed, now faces an intractable situation if he had not planned on
raising rates this week.
Charles
Evans, who served as president of the Federal Reserve Bank of Chicago from 2007
to 2023, said Mr. Warsh would have had more flexibility had he provided more
substance around his own thinking.
This
“framework guidance” is “bread-and-butter monetary policymaking,” said Mr.
Evans. “If you were willing to talk more expansively about the different
scenarios that you see, I think you could go into this meeting and explain
either decision” regarding an increase or a hold.
Several
top officials sought to carve out flexibility for the Fed ahead of September’s
gathering. John C. Williams, who as president of the New York Fed is the
vice-chair of the Federal Open Market Committee, conveyed little urgency to
raise rates when he spoke this month. While he made clear that forthcoming
policy decisions would depend on the data, he leaned into his forecast that
inflation would decelerate later on this year.
Christopher
J. Waller, a governor, was more blunt, questioning the
efficacy of raising rates when there were reasons to be optimistic about
cooling price pressures in the coming months. Still, he said a “hot” inflation
report would probably tip him toward higher rates.
So when August’s inflation data, released on Friday, showed
minimal improvement in price pressures, the Fed seemed bound to raise rates.
“It’s
just going to sow confusion if you sound so tough all the time, but then don’t
back it up,” said Jonathan Pingle, who used to work at the Fed and is now the
chief U.S. economist at UBS. “At this point, a certain amount of credibility is
on the line after throwing down the gauntlet."
The Start of a Series?
When
the Fed raises rates, it is rarely a one-off adjustment. It is often a series
of moves carefully designed to achieve a specific economic goal.
How
much the Fed lifts rates from here depends on what it is trying to achieve.
Economists balk at the idea that a quarter-point increase on its own will do
much to get inflation back to 2 percent. Mr. Warsh himself has spoken out
against the Fed engaging in the “fine-tuning business.”
Slowing
down economic activity enough to bring down inflation is likely to require a
much more substantive move — somewhere in the ballpark of a full percentage
point increase to rates, according to Mr. Evans.
But
if the Fed’s goal is simply to protect against the possibility that inflation
stays stuck at a stubbornly high level — or that expectations about inflation
begin to shift notably higher — it might not have to do as much if it starts
now.
Justifying
a rate increase on Wednesday as a matter of risk management could be effective,
said Kris Dawsey, head of economic research at the D.E. Shaw Group, a hedge
fund.
“With
uncertainty around inflation, erring on the side of more hawkish policy is a
reasonable approach,” he said. “If we continue to observe inflation numbers
that aren’t consistent with more progress toward 2 percent, they could be
prepared to make further adjustments.”
Ms.
Meade said that at minimum, the Fed needed to reverse the insurance it took out
last year when it lowered rates three times to guard against a weakening labor market. Those cuts were a “mistake,” she said, and
hadn’t left enough restraint on demand to keep a lid on inflation when new
shocks emerged.
Providing
specific guidance about the possible trajectory for rates, however, would go
against Mr. Warsh’s own communication preferences. Without a signal, the risk
is that markets begin to pile on bets that are far out of step with what Mr.
Warsh believes is necessary to rein in inflation. That could translate to
overly onerous borrowing costs that could imperil the labor
market or snuff out growth.
One
tool at his disposal on Wednesday will be an updated so-called dot plot, which
aggregates on a quarterly basis what policymakers
surmise will happen to rates over the coming years along with inflation, growth
and unemployment.
But
Mr. Warsh has sought to minimize its importance. When it was last published in
June, and showed that officials were evenly split on the need to raise rates,
Mr. Warsh opted against submitting projections. Now, it is expected to show
another quarter-point increase this year after September’s move. That move is
likely to come in December rather than at the Fed’s next meeting in October,
which comes just days before the midterms. Further increases could also be penciled in for 2027.
“I
don’t think they necessarily have a specific end point in mind,” said Mr.
Dawsey. “If they were already planning a much more substantial adjustment, it
wouldn’t make sense for an inflation print just slightly above expectations to
be the thing that triggered it.”
Litmus Test
Even
one rate increase is likely to anger Mr. Trump.
Lower
borrowing costs have taken on newfound importance for the administration in
recent months, reflecting the centrality that affordability issues are playing
in the midterm elections. Since August, Treasury Secretary Scott Bessent has
unilaterally tried to force down borrowing costs with a series of
interventions. Those efforts have so far proved fruitless.
Perversely,
there is an argument that if the Fed shows it is serious about tackling
inflation and raises rates, it would help keep in check the longer-term
borrowing costs that Mr. Bessent is trying to tame. July’s meeting, and the
market rout that followed, confirmed how sensitive Treasury yields are to any
perception that Mr. Warsh was wavering on his inflation pledge.
Joseph
Lavorgna, who until recently served as an adviser at the Treasury Department,
said this rationale could appeal to the administration. Mr. Warsh has the
benefit of a close relationship with both Mr. Bessent and Mr. Trump, and many
hope he will leverage those ties to handle the repercussions of going against
the president’s stated wishes.
“He
knows what he’s dealing with with the president,”
said Mr. Lavorgna, now chief economist at SMBC Nikko Securities America.
“However, he needs to do what he believes is in the best interest of the
Federal Reserve, and right now inflation is a problem.”