Kevin Warsh faces biggest challenge yet as Fed weighs rate decision

Kevin M Warsh faces a pivotal choice this week at his second meeting as chairman of the Federal Reserve. He has staked his reputation on getting inflation down after half a decade of it running too high for the central bank’s liking. Now, he must decide whether to push for higher borrowing costs to shore up that pledge. Wednesday’s decision offers Warsh his first real opportunity to assert himself, with risks in both directions. 

Corralling his colleagues to raise interest rates would be a surefire way to keep in check the public’s expectations about inflation while silencing critics who question Warsh’s appetite to go beyond talking tough to curb price pressures. The pitfalls are plentiful, however, depending on how Warsh justifies it. A rate rise on the heels of relatively benign inflation data has the potential to sow confusion about how officials will respond to shifts in the economy, testing financial markets that are already jittery amid volatile energy prices stemming from a re-escalation in the war with Iran.  After topping $100 a barrel last week, Brent crude, the international benchmark for oil, retreated to around $90 after a pause in fighting over the weekend. Warsh would also likely have to contend with criticism from United States (US) President Trump, who tapped him for the job and has made clear his desire for lower rates. 

 

Keeping rates unchanged would leave the Fed’s policy options open while giving officials more time to see how the economy is evolving. Many expect inflation to ease in the latter half of the year. By the time the Fed meets again in September, officials will have two more months of data in hand. But inaction will put pressure on Warsh to explain how doing nothing is compatible with his recent assertion to lawmakers that the central bank has “no tolerance” for elevated inflation. 

The decision before Warsh ultimately hinges on the balance he wants to strike between taking an aggressive stance in the early stages of his four-year tenure as chairman and maintaining room to maneuver in an environment where the bulk of inflation is being driven by supply shocks that the central bank’s tools are ill-equipped to address. If inflation was being triggered by an overheating labour market, for example, instead of surging energy prices caused by the war with Iran or Trump’s tariffs, the central bank would feel much more confident about its next steps. 

In the lead up to July’s meeting, two policymakers indicated there was an urgency to raise rates. Lorie K Logan, president of the Federal Reserve Bank of Dallas, and Beth M Hammack of the Cleveland Fed, both emphasised the strain on consumers and businesses caused by elevated inflation and the potential for price pressures to further broaden out. Prices across the services sector, including transportation and shipping costs, as well as expenses tied to eating out or traveling have all risen compared to the same time last year. Logan and Hammack contend that higher borrowing costs are necessary to achieve the Fed’s 2 per cent target. Both are voting members on this year’s policy-setting committee. 

But many of their colleagues, including a handful of the Fed’s most senior decision makers, signalled that while they were ready to act if inflation did not soon ease, they were comfortable taking a wait-and-see approach for now. That included Philip N Jefferson, the vice chair, and John C Williams, president of the New York Fed Christopher J  Waller, a Fed governor, put a heavy emphasis on the latest inflation data in determining the Fed’s next steps. Two reports tracking consumer and wholesale prices in June came in much cooler than expected. Still, he made clear that he would need to see several months of mild data to feel confident about the outlook. 

This distribution of views internally will no doubt produce the “family fight” that Warsh has long encouraged. But it also suggests that he will have latitude to pull officials in one direction or another should he choose to do so. 

Warsh has opted to obscure where he stands publicly to avoid boxing in the Fed. When pressed for more specificity, such as during congressional hearings earlier this month, he was explicit that one month of tepid inflation data did not amount to “mission accomplished.” But in several instances, Warsh’s leaned in a dovish direction. 

Asked by Senator John Kennedy, Republican from Louisiana, what he would do to address inflation, Warsh never brought up the prospect of raising rates. Instead, he said the Fed’s success would be a function of it asserting the central bank’s commitment to getting inflation down, taking responsibility for any failure in doing so and studying its policy tools. When Kennedy asked how the Fed determines if inflation is temporary or persistent, Warsh invoked the five task forces he has created, which he said would “get to the big and hard questions instead of trying to paper it over with policies that have not been proven as successful.”