Kevin Warsh was sworn in as Chair of the Federal Reserve on May 22, heralding a new, reform-oriented era for the central bank. However, just a week into his tenure, the new chief received a stark reality check: the U.S. PCE price index for April rose 3.8% year-on-year, hitting a nearly three-year high.
In a November column, Warsh argued that artificial intelligence would be a "significant disinflationary force" and advocated for the Fed to cut interest rates preemptively, betting on an "AI-driven low-inflation era." His core policy proposals include three key aspects: first, using a combination of "rate cuts and balance sheet reduction" (QT) to balance growth and discipline; second, weakening forward guidance to restore policy flexibility; and third, optimizing the inflation measurement framework by focusing on the "trimmed mean PCE" indicator, which excludes extreme price volatility.
However, the actual data is not cooperating. The core PCE for April rose 3.3% year-on-year, unchanged from the previous month and still stubbornly far above the Fed's 2% target. Meanwhile, the frenzy of AI capital expenditure is itself becoming a new factor pushing yields higher. Brian McCarthy, Chief Strategist at Macrolens, points out that hyperscale cloud service providers have raised their AI capital expenditure guidance to approximately $725 billion this year. This increase is equivalent to 1.3% of GDP, directly driving up growth expectations and bond yields. Ironically, while Warsh had counted on AI to bring disinflation and pave the way for rate cuts, the reality is that the AI investment boom itself is increasing pressure to raise rates.
Warsh faces four major challenges. The first is political pressure from the White House. While President Trump personally presided over Warsh's swearing-in ceremony and demanded his "complete independence," markets widely worry whether this presidentially-appointed Chair can resist political calls for rate cuts. The second is the market risk associated with balance sheet reform. Warsh advocates for a significant reduction in the Fed's balance sheet, but with long-term rates already elevated, moving too quickly could trigger severe bond market turbulence. The third is ideological divergence within the Fed. St. Louis Fed President Musalem has publicly warned against relying on the AI boom to solve inflation, stating that the "AI productivity miracle has not yet arrived." The fourth is the profound transformation of the economic structure. Aging demographics, supply chain restructuring, and geopolitical conflicts are fundamentally altering the mechanisms of inflation formation, risking the obsolescence of traditional monetary policy frameworks.
Warsh proposes shifting the policy anchor from the traditional core PCE to the "trimmed mean PCE"—an indicator that attempts to capture "true underlying inflation" by excluding extreme price swings in categories like energy and food. This measure has currently fallen to 2.5%, significantly below the official figures. If Warsh pushes the Fed to formally switch its observation framework, it could provide a theoretical basis that "inflation is already under control," thereby paving the way for earlier rate cuts.
However, Bank of America poured cold water on this notion in a recent report. Against the backdrop of resurgent core inflation and a clearly more hawkish shift within the FOMC, it will be very difficult for Warsh to persuade the committee to adopt a more dovish stance. Market pricing indicates that investors expect the Fed to hold rates steady this year, with the possibility of the next rate hike not occurring until January 2027.
In his first week, Warsh's "reform blueprint" has been met with a sharp blow from high inflation. Will he stick to his "AI disinflation theory" and cut rates early, or bow to the hawkish data and hold steady? The road for the new Fed Chair is fraught with challenges from the very start.
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