Market Delivers a Blow to Warsh on First Day as Fed Chair: Rate Hike Expected This Year

Jerry Warsh officially took the helm of the Federal Reserve, only to face a sharp market rebuke on his very first day. On Friday, May 22nd, former President Trump presided over a swearing-in ceremony at the White House, formally passing the Fed's leadership to Warsh. As Warsh assumes control, soaring energy and transportation costs stemming from the Iran conflict continue to feed into inflationary pressures. On the same day, Fed Governor Christopher Waller delivered hawkish remarks, explicitly stating that inflation is the "driving force" for future policy decisions and characterizing the odds of future rate hikes and cuts as a "coin toss." This statement directly fueled a sharp increase in market expectations for tightening. U.S. Treasury markets sold off that day, with the yield on the interest-rate-sensitive 2-year note rising by 4 basis points to its highest level since February. Futures markets have now fully priced in expectations for a 25-basis-point rate hike this year. TS Lombard economist Steven Blitz stated bluntly that if Warsh chooses not to raise rates at his first monetary policy meeting in June, the market will not grant him any leniency.

Waller's Hard Pivot: Inflation as Policy "Driving Force"

At the very moment Warsh was being sworn in, Fed Governor Christopher Waller delivered what markets viewed as his most hawkish signal to date in a Frankfurt speech titled "Policy Risks Have Changed," with the stark shift in his stance drawing significant attention. Waller stated that inflation is not moving in the right direction and that he supports removing the "easing bias" language from policy statements to clearly signal that the possibility of rate cuts and hikes is now roughly balanced. He further indicated that he can no longer rule out the potential need for future rate hikes if inflation does not recede promptly. Waller acknowledged that recent labor market reports and inflation data have caused him to alter his previously long-held accommodative stance. He also noted that the oil price shock might soon fade but emphasized this does not mean "considering a rate hike in the near term," adding that a hike would require conditions where inflation expectations become "unanchored." Minutes from the Fed's April meeting had shown that "many" officials were already leaning toward dropping the easing bias, including three regional Fed presidents who dissented on this issue in the April statement. Waller's latest comments align with this trend.

Warsh's Debut Looms: Immense Pressure for June Meeting

Warsh is set to chair his first Federal Open Market Committee (FOMC) meeting in mid-June, and market observers are not optimistic about the situation he will face. The Fed's preferred inflation gauge has risen to its highest level in three years, with overall price growth reaching 6% in April. Market-implied one-year inflation expectations are around 4%. TS Lombard economist Blitz added that if Warsh decides against a hike in June, even if economic growth remains solid and far from overheating, the market would interpret it as a form of easing. Blitz said that failing to hike in June amid broadly rising inflation risks would, in effect, equate to a policy loosening. KPMG U.S. Chief Economist Diane Swonk pointed out that Middle East tensions are adding to pre-existing price pressures. She noted this is one of many reasons the Fed cannot afford to ignore the war and its inflationary impacts. Current market expectations for a 25-basis-point Fed hike stand in stark contrast to the widespread bets on multiple rate cuts seen earlier in the year. Although the 10-year Treasury yield did not surge significantly this week, influenced by declining energy prices, Goldman Sachs's George Cole noted that while long-end Treasuries appear slightly cheap relative to fair value, the mispricing is not yet sufficient to support a much deeper rally. George Cole emphasized that until the macro risk landscape shifts materially, long-end yields still face supply pressures and structural upside risks from the debt financing cycle.

Test of Independence: Concerns Behind a Historic Inauguration

Warsh is the first Fed chair to be sworn in at the White House since Alan Greenspan, a detail the market itself views as a signal. Former President Trump had hoped the former Fed governor he nominated in January would be more amenable to calls for rate cuts, after Warsh prevailed in the nomination contest over White House economist Kevin Hassett, Governor Waller, and BlackRock executive Rick Rieder. Pressure on the Fed's independence has been particularly pronounced recently. Former President Trump's ally, D.C. federal prosecutor Jeanine Pirro, had previously opened a criminal investigation into Chair Jerome Powell regarding a $2.5 billion headquarters renovation project. Although the investigation was dropped, Powell characterized it as a pretext to pressure officials for rate cuts. Warsh now begins a four-year term as the 17th chair of the Federal Reserve Board. However, the market has made it clear: regardless of the political environment, inflation is the most pressing issue at hand, and the new chair has very little time to settle in.