The selection of Kevin Warsh as Federal Reserve Chair was partly based on his proposed roadmap toward lower interest rates. However, the new Fed chief now confronts a starkly different reality: how to manage a sudden market shift toward expectations of higher rates, even as fellow policymakers warn of resurgent inflation.
New data released Thursday highlighted this challenge. The Fed's preferred inflation gauge rose 3.8% over the 12 months ending in April. This marks the highest level since 2023 and is nearly two full percentage points above the central bank's 2% target.
Fed watchers suggest that the window for rate cuts has closed, influenced by energy shocks stemming from the conflict in Iran. For Warsh, simply maintaining the current policy rate may now be considered a success.
"The market currently has no appetite for rate cuts at all," said Stephanie Ross, Chief Economist at Wolfe Research. "Warsh must demonstrate the ability to push back against market expectations that have already priced in rate hikes—this is his biggest challenge this year."
How Warsh steers the narrative on interest rates in the coming months could define his leadership style and shape his ability to demonstrate the Fed's independence. While President Trump has stated he expects Warsh to act independently as Fed Chair, underlying political pressure for lower rates persists.
Just hours after presiding over Warsh's swearing-in ceremony last week, Trump remarked that he expects rates to come down "very quickly."
A Shift in Expectations This shift in the expected rate path coincides with forecasts that energy costs will remain elevated in the coming months, even if the Iran conflict subsides. Additionally, surging investment flowing into artificial intelligence (AI) is adding to broader inflationary pressures.
These factors have prompted a series of Fed officials in recent weeks to warn that the central bank can no longer signal that rate cuts remain a likely next step. Instead, they are leaning toward highlighting the risk of policy tightening—a dramatic reversal from early this year when officials projected further easing into 2026.
In an interview Thursday, St. Louis Fed President Alberto Musalam stated that policymakers must consider the possibility of rate hikes in the coming months as "greater than zero." Meanwhile, New York Fed President John Williams noted he views current policy as well-positioned to handle the war's impacts.
To be clear, these warnings do not mean officials intend to raise rates imminently. An end to the Middle East conflict would give policymakers time to assess its effects, and a labor market caught in a "low-hiring, low-firing" cycle provides an argument against tightening.
"We believe the bar for raising rates was higher than the bar for cutting rates even before Kevin Warsh took the helm at the Fed," said Robert Sorkin, Chief U.S. Economist at PGIM.
Nevertheless, it is evident that inflation has entered a territory few anticipated at the start of the year.
The Consumer Price Index (CPI) for April posted its largest increase since 2023, prompting investors to shift bets from rate cuts to hikes. Long-term inflation expectations have also been jolted. According to the University of Michigan's May consumer survey, consumers expect prices to rise at an annualized rate of 3.9% over the next 5 to 10 years, up from 3.5% in April and reaching a seven-month high.
"Warsh now finds himself in a position where, rather than making a case for rate cuts, he must expend effort to fend off growing pressure from colleagues and the public to tighten policy, or at least maintain the status quo," said Derek Tang, an economist at Washington-based LH Meyer/Monetary Policy Analytics.
Policy Loosening May Already Be Fueling Inflation There are other reasons to believe current policy may be stoking inflation rather than cooling it.
Matt Luzzetti, Chief U.S. Economist at Deutsche Bank, warned that the Fed may have cut rates excessively in 2024 and 2025, resulting in overly accommodative policy. Such concerns become more acute whenever inflation rises, as it elevates the level of interest rates considered "neutral policy"—neither restrictive nor stimulative for the economy.
"If you do nothing, you are effectively easing policy," said Fabio Natalucci, CEO of the Andersen Institute of Finance and Economics and a former official at both the Fed and the International Monetary Fund (IMF).
Most Fed officials view current policy as around or still slightly above neutral levels.
Tensions within the Fed could peak at the June policy meeting, where officials may remove the so-called "easing bias" from their policy statement. They will also submit new projections, likely including higher inflation forecasts and at least a delayed timeline for future rate cuts.
A particularly notable example: Fed Governor Christopher Waller, a strong advocate for rate cuts in 2024 and 2025, now supports explicitly signaling that the next rate move is as likely to be a hike as a cut.
"The reality is that inflation has become sticky," said Diane Swonk, Chief Economist at KPMG. "Warsh is stepping into a shifting narrative."
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