Federal Reserve Chairman Kevin Warsh delivered exactly what Wall Street was clamoring for this week: drawing a line in the sand against inflation while offering clarity on how the central bank would respond to rising prices.
Harvard professor and former chief economist of the International Monetary Fund, Ken Rogoff, said Warsh made it clear that if the inflation data didn’t improve, he’s going to hike interest rates.
“That surprised me because my layman political economic view of the situation was that if the Fed could possibly put that off until after the midterms, it would be good for the Fed as an institution,” Rogoff said in an interview.
“By hiking, they demonstrate independence. On the other hand, democracy is under assault, and if he hikes rates, you just don’t know what the consequences are going to be.”
Rogoff predicts that if the Fed raises rates at its September policy meeting, the central bank will face fierce backlash from President Trump. Following Warsh’s speech, market odds for a September rate hike surged to 60%, up from 35% the previous day.
“If Trump gets trounced in the midterms, and they hike rates in September, they’re going to take a lot of heat over it and not in a minor way,” he said. “It took some courage to do what he was doing, but I think, he felt if he laid it out clearly, he didn’t say he was going to hike.”
Rogoff originally expected Warsh to merely signal a future September hike rather than pull the trigger.
“This clearly opened the door to a hike if the data supports it, and I think the data have to solidly support it,” he said.
Rogoff noted that Warsh’s speech, which he called his best so far, cleaned up confusion following his press conference in July when Warsh repeatedly pointed to bond yields that shot materially higher when asked about whether the Fed would raise rates to corral inflation, leading markets to question whether there was a credible strategy to bring down inflation.
“He was obviously very nervous about Trump and Treasury Secretary Bessent leaning over his shoulder,” said Rogoff of the July press conference. “I guess after watching Bessent get raked over the coals, that probably made it easier for him to do this.”
The Harvard professor was referring to Secretary Bessent’s announcement to double the Treasury’s buybacks of long-term Treasurys.
“It was very badly received in the bond market,” added Rogoff.
In the near term, Rogoff expects long-term bond yields to climb, predicting that the 10-year Treasury yield will be higher a year from now. He heavily criticized Treasury Secretary Bessent’s current strategy.
“Bessent seems to be operating on the view that long-term rates are temporarily too high, and he should move borrowing to the short end,” said Rogoff. “He’s been doing everything possible to do short-term borrowing because he thinks rates are going to go down. Good luck with that.”
Rogoff maintains that the recent rise in inflation-adjusted “real yields” is simply a normalization. He rejects the idea that low yields were driven by demographics or low productivity, viewing them instead as prolonged ripples from the 2008 financial crisis and the pandemic.
Looking further down the road, Rogoff maintains there are structural forces –including shifting demographics, widening inequality, and global warfare—will continue to exert upward pressure on interest rates.
“The US is going to have to massively increase military spending and if the Democrats control Congress, they will have to figure out somehow how to rationalize that,” he said.
“The market needs to hear the debt consolidation story, and all [Bessent] has to say is growth is going to be fantastic,” said Rogoff. “They’re still sinking, and I think actually it was important for Warsh to say we’re not sinking with you, we’re raising the interest rate if we need to.”
Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance, she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.