Federal Reserve Chairman Kevin Warsh’s first full week leading the central bank featured unfavorable economic reports that suggest his job is going to be difficult.
Warsh, 56, was sworn in as Fed chairman on May 22 during a ceremony at the White House and is facing the tricky task of contending with rising inflation and the prospect that the central bank’s interest rate target might have to remain higher for longer or even be hiked.
MARKET EXPECTATIONS FOR A RATE HIKE HAUNT WARSH AND GOP
The first inflation numbers under Warsh were released Thursday and showed that inflation in the personal consumption expenditures price index rose to 3.8% in April, well above the Fed’s 2% target and much higher than just a few months ago before the war with Iran sent energy prices spiking.
The Bureau of Economic Analysis reported the same day that GDP for the first quarter was revised down 0.4 percentage points to 1.6%.
“It’s a pretty tough situation for an incoming Fed chair,” Jai Kedia, an economist at the Cato Institute, told the Washington Examiner.
Further complicating matters is that President Donald Trump assailed former Fed Chairman Jerome Powell for months over the Fed’s refusal to cut interest rates. With the higher inflation, investors think it is highly unlikely that Warsh can convince the Fed board to lower interest rates this year. In fact, there might even be a rate hike.
As of Friday, the implied odds of a rate increase before the end of the year were over 43%, according to CME Group’s FedWatch tool, which calculates the probability of rate changes using futures contract prices for rates in the short-term market targeted by the Fed. The odds of a rate cut are marginal at best.
But while Trump has pushed for lower rates, Warsh might be granted a reprieve from that agitating — at least for the time being.
“I think what you’ll see is first kind of an appropriate honeymoon period for Kevin Warsh, meaning they will not be on his case immediately,” Dennis Lockhart, a former Federal Reserve Bank of Atlanta president who worked with Warsh for several years at the Fed, told the Washington Examiner.
And Trump has indicated as much.
Trump shifted his tone on the matter during a recent phone interview with the Washington Examiner.
“I’m going to let him do what he wants to do,” Trump said in response to a question about Warsh and market expectations for a rate hike. “He’s a very talented guy, he’s going to be fine, he’s going to do a good job.”
During Warsh’s swearing-in ceremony, Trump further vowed to let Warsh handle the Fed free of White House influence.
“I really mean this, I want Kevin to be totally independent,” Trump said. “’Don’t look at me, don’t look at anybody, just do your own thing and do a great job, OK?’”
But how long that will hold up is anyone’s guess. And Powell himself was also nominated by Trump.
“Trump made Powell’s life much harder by constantly interfering with rate decisions,” Kedia said.
Lockhart said there are some “sober voices” advising Trump and are undoubtedly pointing out to him that, with inflation rising, it would be a policy error to further cut interest rates.
“The conventional wisdom would be that you’re adding stimulus in the face of rising prices, and stimulus would just engender more price pressure because it’s stimulating more demand,” Lockhart said.
At a 1.6% growth rate in the first quarter, the economy is still strong enough to withstand some headwinds. But a significant slowdown could bring the economy to a standstill, or even push growth negative. At that point, the U.S. would face both a recession and high inflation.
“Obviously, you want there to not be also real economy, labor market pressures along with inflation, because that’s the worst of both worlds,” Kedia said.
And the war in Iran has played a big role in the latest bout of inflation. One way to avoid a rate hike is for the conflict in Iran to die down and for the Strait of Hormuz to reopen. That could put downward pressure on energy prices, and thus headline inflation, making a rate increase far less likely.
Still, Thomas Hoenig, a senior fellow at the Mercatus Center and former president of the Federal Reserve Bank of Kansas City, pointed out that inflationary pressures were already building ahead of the war, and inflation was still running above the Fed’s 2% target.
“You had some momentum for inflation even before the war, now the war complicates that picture — it makes inflation worse,” Hoenig told the Washington Examiner.
CONSUMER SENTIMENT PLUNGES TO RECORD LOW AS INFLATION TRENDS UP AGAIN
Hoenig, who was also previously vice chairman of the Federal Deposit Insurance Corporation, said Warsh is staring down a challenge coming into the Fed, given the macroeconomic landscape.
“He and the [monetary policy committee], as well as others, are in a very uncertain economy right now, and they have to work their way through it and not make errors on either side that are too big, and that’s his challenge,” he said.
