If the Federal Reserve decides to keep rates unchanged this week, Fed Chair Warsh will once again face a familiar challenge: he must convince investors that the Fed is committed to curbing inflation while explaining why officials chose not to raise rates.
This is exactly the situation Warsh encountered in July. At that time, investors took the Fed's decision to hold rates steady in stride, but were displeased with Warsh's reluctance to signal that borrowing costs might need to rise further.
After the September rate hike, the Fed is expected to hold rates steady again this week. This shifts market attention to December. Markets widely believe there is a strong possibility the Fed will implement its second rate hike of the year at that time.
Stephen Stanley, chief economist at Santander U.S. Capital Markets, said: "I don't expect rates to change, but I do think they will hike again in December. The communication challenge at this meeting is that Warsh needs to explain why they didn't hike in October. After laying out that reasoning, he must also explain why a December hike remains a realistic option."
Warsh may get some help from his colleagues. One or more Fed officials could dissent from the decision to hold rates steady, becoming the first to make the case for a December hike. But none of these officials can speak on Wednesday, presenting Warsh with a challenge he may not wish to face. Since joining the Fed in May, he has consistently refused to provide markets with guidance on the future path of rates.
Warsh believes that although other policymakers have limited support for this view, forward guidance is often misinterpreted as a Fed commitment to a specific future decision and should therefore be used only during economic crises. In such situations, a genuine commitment can significantly enhance the effectiveness of Fed policy actions. However, he says that when officials are merely making relatively minor policy adjustments aimed at keeping the economy broadly balanced, providing forward guidance can constrain the Fed's flexibility.
As a result, beyond reiterating the Fed's firm commitment to bringing inflation back to its 2% target, Warsh has revealed virtually nothing about future rate decisions. Instead, he advises investors to focus on economic data when predicting rate movements.
This approach has already caused trouble. At the press conference following the Fed's July decision to hold rates steady, Warsh's remarks were too brief, sending markets into turmoil. At the time, investors were eager for assurances that the Fed would act if price pressures intensified. Warsh subsequently adjusted his communication strategy in an August speech, revealing more of his policy thinking and taking a more hawkish stance on inflation. At the following September meeting, he and his colleagues reinforced that stance with a rate hike and used quarterly rate projections to signal that the Fed would likely hike once more in the remaining two meetings of the year.
In the weeks since, however, the inflation picture has worsened further. Elevated oil prices continue to pass through the entire economy, and the wide spread between crude oil and refined products has amplified this effect. This pushed both September consumer prices and wholesale prices higher. Meanwhile, robust demand from artificial intelligence (AI) infrastructure investment continues to drive up prices for materials, components, and electricity, which in turn has raised prices for consumer electronics, personal computers, and electricity rates.
Aditya Bhave, head of U.S. economic research at Bank of America, said: "The reason they gave for hiking in September was that inflation was becoming worrisome. Since then, on balance, the inflation situation has gotten worse." He expects the Fed to deliver a surprise rate hike next week.
In response, investors followed Warsh's advice, scrutinizing economic data and beginning to price in an October hike—until key officials intervened and shifted market expectations. In speeches on September 29 and October 1, New York Fed President John Williams and Fed Board Vice Chair Philip Jefferson respectively indicated that the Fed could afford to be patient and need not rush to consider when to next raise rates. Another closely watched policymaker, Fed Governor Christopher Waller, conveyed a similar message.
The signal seemed unusually clear. Investors concluded that the economic data had been released and forward guidance had returned—at least for October. Market-implied odds of a rate hike consequently fell from above 70% to below 30%.
On October 16, when Warsh spoke at the International Monetary Fund (IMF) annual meetings in Bangkok, he had an opportunity to realign market expectations with recent inflation data, but he did not do so. He said global conditions since the September meeting had been "broadly in line with our expectations."
On Wednesday, when Warsh steps up to the microphone, he will face pressure not only to explain why rates are being held steady but also to clear up the confusion created by this messy policy communication.
Election shadow
Meanwhile, the political backdrop persists. Although President Trump blamed Warsh's colleagues, he still sharply criticized the Fed's September rate hike. If the Fed were to hike again this week—just days before critical midterm elections—it could provoke a fierce reaction from the White House.
As successive Fed chairs have consistently done, Warsh will almost certainly deny that elections have any influence on rate decisions. However, he can also offer other reasonable explanations. Like Williams and Jefferson, Warsh can emphasize that after the September hike, the Fed still has time to analyze economic data that will be released before the December meeting. By December, officials will have the September inflation gauge they value most, multiple October inflation readings, October and November employment data, and the first estimate of third-quarter gross domestic product (GDP).
Warsh may also reiterate his view that rising long-term U.S. Treasury yields are helping the Fed achieve its policy goals. Until last week's surge in buying, the 10-year U.S. Treasury yield had remained above 5% for a month. This has pushed up borrowing costs across everything from housing and autos to credit card debt.
However, if Warsh is willing to defend the decision to hold rates steady, he must tread carefully to avoid appearing overly optimistic about inflation, lest he trigger another bout of violent market swings. Kathy Bostjancic, chief economist at Nationwide, said: "If they don't tighten monetary policy, there is indeed a risk that the impact of higher energy prices could spread further. Standing pat could unsettle bond investors and cause long-term rates to spiral out of control."
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