Key Section: The Shift in Policy
Sources familiar with Federal Reserve Chair Kevin Warsh's thinking indicate he is preparing to raise interest rates at the September meeting if upcoming inflation data remains strong and market expectations for higher borrowing costs continue to rise. This development was reported on the evening of August 6.
Market Reaction
The news has weighed on gold and silver prices, sending them lower, while the U.S. dollar index has moved higher. Data from the Chicago Mercantile Exchange Group shows that futures markets currently assign roughly a 55% probability to a 25-basis-point rate hike in September.
Long-term borrowing costs in the U.S. surged sharply after last week's Federal Reserve meeting. Investors have expressed concern that Warsh has not adequately explained how he plans to control inflation triggered by the conflict with Iran under President Trump.
Strategic Errors and Communication
People close to Warsh acknowledge he has made some missteps in his first ten weeks leading the world's most important central bank. These include failing to consistently reinforce the core message of price stability and not clearly explaining whether his long-term plan to reform the Fed would affect near-term policy decisions, leading to market confusion. However, these sources insist such errors are not enough to deter Warsh from pursuing his reform agenda.
The Fed has failed to meet its 2% inflation target for over five consecutive years. A central pillar of Warsh's strategy is to significantly reduce the amount of policy guidance the central bank provides to markets. He reiterated this point multiple times following last Wednesday's Fed meeting.
Market Trust and Inflation Expectations
Last week, the yield on the 30-year U.S. Treasury bond rose to its highest level since 2007. Many investors believe this rally partly reflects market concern that Warsh's limited communication style, in an environment of high energy prices that could further push up overall costs, has eroded trust in his ability to control inflation.
Nevertheless, Warsh's associates point out that market-based measures of inflation expectations remain low and have declined in recent days, suggesting investors still believe the Fed will stick to its 2% price stability goal. Data from the Fed's closely watched inflation swaps show investors expect average inflation of 2.4% over the five-year period starting five years from now.
Given that price pressures have been elevated for five years, some argue Warsh's credibility was destined to be tested from the outset. Market concerns may not fully dissipate until inflation actually falls back to 2%. The Fed's preferred inflation gauge stood at 3.7% in June.
President Trump's repeated attacks on Warsh's predecessor, Jerome Powell, for not lowering borrowing costs significantly enough have also made it harder for the new Fed Chair to convince investors he is a committed inflation fighter.
Voices Calling for Action
Several Fed officials have now publicly called for rate hikes. Fed Governor Lisa Cook reiterated that she is ready to raise rates if inflation does not slow. She warned that policymakers may not have the patience to wait much longer for inflation to return to its 2% target.
Cook supported the Fed's decision to hold rates steady at the July policy meeting, but cautioned that the longer inflation stays above the central bank's target, the more difficult it will be to bring it down. Speaking at an event in Alaska on Wednesday, Cook stated: "If I don't see signs of sustained inflation decline soon, I will be prepared to act. Inflation has been above target for five years, and there is a growing risk it could become entrenched in corporate pricing and wage-setting behavior. Once that persistence sets in, it will be much harder for us to deal with."
Minneapolis Fed President Neel Kashkari said the Fed should begin gradually raising rates now to curb still-excessive inflation. "With more data coming in, now is the time to start slowly raising rates," Kashkari said in an interview Wednesday. He was one of three officials who dissented at last week's Fed policy meeting, voting against holding rates steady and instead favoring a 25-basis-point hike.
Kansas City Fed President Jeff Schmid stated that further rate increases may be necessary to achieve the central bank's price stability goal, while reiterating that inflation remains his primary concern. "Given that demand and investment remain strong, I do not believe the current monetary policy stance is restrictive," Schmid said in a speech Tuesday. "Therefore, I believe a more restrictive policy is needed to bring inflation down to the Fed's 2% target."
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