MW April's inflation spike leaves Warsh and the Fed zero excuses on interest rates
By Jai Kedia
Bond markets won't wait for the central bank to combat inflation
New Fed Chair Kevin Warsh must be decisive about U.S. interest rates and inflation - or the bond market will decide for him.
The annualized three-month inflation rate is running at 7.1%
Americans are unhappy with their cost of living. A recent survey found that 69% of Americans disapprove of how President Donald Trump has handled inflation - his worst rating on any economic issue. With U.S. midterm elections approaching, that number carries real political weight. Households have lived through above-target inflation for years now and will likely bring affordability grievances with them to the voting booth.
April's Consumer Price Index release shows that these affordability concerns are only getting worse. The headline year-over-year figure came in at 3.8% - the highest since May 2023 and nearly double the Federal Reserve's 2% target. But year-over-year measures lag; they blend today's momentum with price changes from 12 months ago, obscuring whether inflation is accelerating right now.
A sharper gauge is the annualized three-month rate: the pace of price increases over the most recent quarter, scaled to a full year. On that measure, headline inflation is running at 7.1% - the highest since the peak of the post-pandemic surge in late 2022. Core inflation, which strips out food and energy, is 3.2% annualized, more than one-and-a-half times the Fed's target. Neither figure is consistent with price stability.
The immediate driver is the Iran war. Gasoline posted a 21% surge in March - the largest monthly gain on record - and rose another 5% in April as the Iran conflict deepened. But energy costs don't stay contained; they propagate because they are a key input for many goods and services.
This is what economists call a cost-push shock: Rising input costs work through the supply chain, lifting intermediary material costs and overheads. Increased costs of production are eventually passed through to consumers at retail. April's report made this visible in real time, with the core reading accelerating to its highest pace since early 2024. The supply shock has already started to bleed into broader price trends.
So far this year, the Federal Reserve's response has been keeping rates steady. Supply shocks are notoriously hard for a central bank; if the Fed tightens incorrectly consumers could end up with fewer products because of the shock and less credit because of the Fed. The standard defense of Fed inaction ("seeing-through" supply shocks) in such situations invokes the dual mandate: Supply shocks inflict pain on both inflation and employment, leaving the central bank without a clean directional signal.
Read: 5 tests Kevin Warsh will face as Fed chair
But there are often many shocks affecting the economy at once. Whether the balance of risks shifts toward inflation or employment can only be answered by looking at the data. April's unemployment rate held steady at 4.3%. Employment did not fall in any measure commensurate with the price increases. The balance of risks, on the Fed's own terms, tilts decisively toward inflation.
The Iran war is the fourth significant supply shock in five years. Each time, the Fed chose the same posture: assess; equivocate, delay. Post-pandemic inflation was famously called "transitory." The Ukraine war's energy spike was treated as temporary. The tariff-driven price pressures of 2025 prompted the Fed to keep signaling rate cuts, even as inflation data argued against them.
No one can predict how the current conflict evolves or how persistent the energy shock proves. But that is precisely the danger of a central bank that reserves the right to discretionarily ignore economic data; each new one becomes another reason to delay, and the accumulated cost is a price level substantially above where it would have been under a more disciplined framework.
The best objective standard for where rates should be is a policy rule. Commonly used monetary policy rules such as the Taylor rule would advocate a federal funds rate target over 5% based on headline inflation. The current target is between 3.5% and 3.75%. Even the conservative core CPI inflation reading would correspond to at least a 25-basis-point increase to the Fed's current target range.
To be clear, tightening is not costless. Higher rates raise borrowing costs for households and businesses, strain credit markets and increase the federal government's already burdensome interest expenses. This will all be compounded because the Fed has consistently used forward guidance to signal that conditions will eventually ease - an issue that led to four historic dissents at the most recent FOMC meeting.
Fed inaction carries far worse costs: Inflation expectations can drift and entrench this high inflation, making the eventual correction sharper. Moreover, as the recent past has shown, bond markets won't wait for the Fed and new Chair Kevin Warsh. If private actors see worrying signs they will demand higher compensation on assets, raising yields. Both prices and borrowing costs can rise together, leaving households with the worst of both worlds.
The best way for the Fed to ease Americans' affordability concerns is not to play fortune teller with each crisis and hope for the best. It is to stop treating discretion as a viable monetary policy strategy and return to letting data guide rate decisions in an objective manner.
Jai Kedia is a research fellow at the Cato Institute's Center for Monetary and Financial Alternatives.
More: Inflation will likely be higher for longer. Your retirement plan isn't built for that.
Also read: The Iran war could be a $300 billion shock - driving up mortgage rates and squeezing wages
-Jai Kedia
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 13, 2026 16:48 ET (20:48 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
Comments