The appointment of Kevin Warsh as Federal Reserve Chair was partly predicated on his outlined path toward lower interest rates. However, the new Fed chief now confronts a starkly different reality: how to curb a sudden market pivot toward expectations of higher rates, even as fellow policymakers warn of resurgent inflation. New data released Thursday laid bare this challenge. The Fed's preferred inflation gauge rose 3.8% in the 12 months through April, marking the highest level since 2023 and nearly two full percentage points above the central bank's 2% target.
Fed observers note that the window for rate cuts has closed, influenced by energy shocks stemming from the Iran conflict. This implies that for Warsh, merely holding the current rate level could be considered a victory. "The market currently has zero appetite for rate cuts," said Stephanie Ross, Chief Economist at Wolfe Research. "Warsh must possess the ability to push back against market expectations that have already priced in rate hikes—this is his greatest challenge this year."
How Warsh steers the rate narrative in the coming months may define his leadership style and demonstrate his capacity to uphold the Fed's independence. Although 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 anticipates rates coming down "very quickly."
**Shifting Expectations** Amid this pivot in expected rate trajectories, energy costs are forecast to remain elevated in the coming months, even if the Iran conflict subsides. Furthermore, surging investment flowing into artificial intelligence (AI) is amplifying broader inflationary pressures. These factors have prompted a series of Fed officials to warn in recent weeks that the central bank can no longer signal that rate cuts remain a likely next step. Instead, they are leaning toward highlighting the risks 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 Musalem stated that the probability of policymakers considering rate hikes in the coming months "has to be greater than zero." Meanwhile, New York Fed President John Williams indicated he views current policy as well-positioned to handle the war's impacts.
To be clear, these warnings do not signify officials intend to raise rates imminently. An end to the Middle East conflict would grant policymakers time to assess its effects, and a labor market caught in a "low-hiring, low-firing" cycle provides a counterargument against tightening. "We believe the bar for hiking was higher than the bar for cutting even before Kevin Warsh joined the Fed," noted Robert Sorkin, Chief US Economist at PGIM.
Nevertheless, it is evident that inflation has entered a territory few anticipated at the start of the year. April's Consumer Price Index (CPI) recorded 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 now 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 hitting a seven-month high.
"Rather than making the case for rate cuts, Warsh now has to expend energy fending off growing pressure from colleagues and the public to tighten policy, or at least hold the line," said Derek Tang, an economist at LH Meyer/Monetary Policy Analytics in Washington.
**Policy Loosening May Already Be Fueling Inflation** There are additional reasons to believe current policy may be stoking inflation rather than cooling it. Matt Luzzetti, Chief US Economist at Deutsche Bank, warned that the Fed may have cut rates excessively in 2024 and 2025, resulting in overly accommodative policy. Such concerns intensify whenever inflation rises, as higher inflation elevates the interest rate level deemed "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 for Finance and Economics and a former staffer at the Fed and the International Monetary Fund (IMF). Most Fed officials view current policy as around neutral or still slightly above it.
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 stating that the next rate move is as likely to be a hike as a cut.
"The reality is inflation has become sticky," stated Diane Swonk, Chief Economist at KPMG. "Warsh is stepping into a narrative shift."
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