Kevin Warsh, who is expected to be confirmed by the Senate later this month as the next Federal Reserve chair, will inherit a central bank that appears to be stuck in policy limbo due to concerns about escalating inflation. But Warsh may have more options than investors think.
Bond traders no longer expect the Fed to cut interest rates this year. Three of the Fed's regional bank presidents broke ranks at the April 28-29 policy meeting to vote against language that suggested the next rate move would be a cut. And a May inflation report, due early next week, is widely expected to show prices rising at an annual pace near 4%, almost double the Fed's 2% target.
The dominant view on Wall Street is that Warsh will be boxed in: While the Trump administration is pressing for rate cuts, the Fed's policy committee is heading in the opposite direction. But that assessment underestimates both the man and the moment.
Warsh has a workable path to satisfy both constituencies, and it runs through the middle. If he convinces the Federal Open Market Committee to hold rates steady through the summer, removes the Fed's current signal that a cut is coming, and waits for more clarification on the impact of energy prices. he will accomplish three things: satisfy the hawks on his committee, deny the White House an easy target, and preserve the credibility he will need to make larger moves later this year.
The three regional Fed presidents who dissented at the central bank's April meeting -- Beth Hammack of Cleveland, Neel Kashkari of Minneapolis, and Lorie Logan of Dallas -- didn't vote to raise rates last month. Rather, they voted against the suggestion that the Fed's next move would be a cut. A more neutral FOMC policy statement under Warsh would give them what they have publicly asked for without committing the Fed to tighten monetary policy. It would also grant Warsh a unified committee, perhaps on his first vote.
Meanwhile, the view from the White House appears to be moderating. Treasury Secretary Scott Bessent, who pushed aggressively for rate cuts earlier this year, softened that position in recent weeks, giving Warsh political cover that current Chair Jerome Powell never enjoyed. Powell has been the target for the past year of public attacks from President Donald Trump, who has threatened to fire him and pushed the Justice Department to investigate his conduct in office, a move widely thought to stem from Powell's refusal to cut rates as quickly as the White House wanted.
With Bessent no longer publicly demanding cuts, Warsh has time to wait without looking like he is defying the White House.
Investors have already adjusted their expectations to reflect a Fed on pause. Futures contracts tied to the Fed's policy rate barely move on the assumption of a hold, and the recovery in stock prices since their March lows reflects, in part, ebbing concern about the future policy path.
"The market has all but given up hope for a rate cut in 2026," Darius Dale, of the research firm 42 Macro, wrote in a recent note.
Holding rates steady would merely confirm what is already priced in.
By keeping the federal-funds rate unchanged over the summer at a current target range of 3.50%-3.75%, Warsh would buy time to make other changes at the Fed that he has long advocated. Among them, he wants to trim the Fed's $6.7 trillion balance sheet and reduce Fed officials' focus on reported economic data. Warsh has been among the sharpest critics of the Fed's decision-making process, arguing that the policy committee reacts too mechanically to each new economic report, producing inconsistent policy.
One likely change under a Warsh Fed could be the way officials read inflation. The Fed's preferred inflation gauge is core PCE, or the personal consumption expenditures price index excluding food and energy. A separate gauge, CPI, or the consumer price index, is calculated by the Labor Department using a different methodology and a different basket of goods. Core CPI has been running below core PCE in recent months, which is unusual, in part because the two indexes weigh certain categories differently.
Warsh's preference is to lean on trimmed mean inflation, a measure that he says removes temporary noise, providing a clearer signal of the economy's underlying price trend.
This measurement, which has critics and fans, discards the categories with the most extreme inflation readings on both the high and low ends. Based on trimmed mean measures, inflation appears much closer to the Fed's target than the headline numbers suggest, building the case for eventual cuts. Warsh has also said that artificial intelligence will hold inflation down over time.
The bigger reform on Warsh's mind is the size of the Fed itself, and it is the clearest reason he can't afford to spend his credibility on a quick rate cut. He has argued for years that the central bank's balance sheet, the portfolio of bonds it holds to influence financial conditions, has grown far beyond what the economy needs.
When he joined the board in 2006, the balance sheet was about $800 billion. Successive rounds of bond-buying during the financial crisis and the Covid pandemic pushed it to a peak near $9 trillion before the Fed began letting some holdings run off. He has suggested it should be closer to $3 trillion than the current level.
Shrinking the balance sheet and cutting interest rates may sound contradictory, but Warsh has said these moves could work in concert. Selling off bonds, or letting them mature without replacement, would tend to push long-term interest rates higher because private investors would have to absorb more supply. Cutting the short-term policy rate would push in the opposite direction.
The combination could let Warsh shrink the Fed's footprint without choking off the economy. But it is a delicate sequence that requires the confidence of the committee, which is exactly what an early, contested rate cut would put at risk.
David Kelly, chief global strategist at J.P. Morgan Asset Management, has pointed to December as a plausible window for a first rate cut, with two more possible in 2027 if growth and inflation both settle below 2%.
Warsh will have a lot to manage from his first day at the Fed. Inflation will test him almost immediately, and numbers well above the Fed's target could force the committee to harden its language faster than he would prefer, narrowing his room to maneuver. The hawks could push further, moving from objecting to easing language to actively pressing for a interest-rate hike if energy prices keep climbing. A sustained energy shock that spreads into the prices of other goods and services would undermine the case for looking past the recent inflation data entirely.
Powell's decision to stay on as a Fed governor after his term as chair ends also may limit Warsh. While Powell has promised to keep a low profile, his continued presence may narrow the reform agenda Warsh has spoken about.
But Warsh's path to achieving his goals exists, and it is more navigable than the current consensus allows. The patient course, in this case, is also the ambitious one for Warsh.
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