By Howard Schneider
WASHINGTON, Sept 2 (Reuters) – After opening the door to higher interest rates last week, U.S. Federal Reserve Chairman Kevin Warsh has to decide how to follow through with actions the public and investors will see as both consistent with his own words and independent of President Donald Trump’s wishes.
Failing those tests could be a blow to the new Fed chief’s credibility. Passing them may mean a rate hike later this month, a powerful signal from the U.S. central bank’s policy committee — less than two months before key congressional elections — that Trump has failed to contain inflation and will not get the Fed’s help in lowering borrowing costs on the rising national debt.
In a speech to the Kansas City Fed’s annual Jackson Hole conference in Wyoming on Friday, Warsh went further than many observers expected in agreeing that higher rates may be needed to curb inflation that is stuck above the central bank’s 2% target.
He will face problems, however, “if the data for August do not line up well with the decision the committee makes in September,” said Robert Tetlow, a former senior policy adviser at the Fed. “Having campaigned so transparently for the job makes the scrutiny he is facing that much more intense.”
Trump has said he believes Warsh, appointed by the president to lead the central bank, wants to cut rates but is prevented by others at the Fed whom the president sees as “hostile” and “political.” Trump on Monday repeated that the U.S. should have “the lowest interest rates anywhere in the world,” despite $40 trillion in outstanding government debt and high annual deficits, but said Warsh would “do what he has to” and still had his respect.
Now that the Fed chief has laid down a rate-hike marker of his own, “the onus is on Warsh to deliver. … Otherwise, he risks undermining some of the credibility he gained,” Aditya Bhave and Shruti Mishra, U.S. economists at Bank of America, wrote following the Jackson Hole speech.
Fed policymakers will meet on September 15-16. Investors now see a roughly two-to-one chance the central bank will approve a quarter-percentage-point hike in the overnight policy rate, which has been held in the 3.50%-3.75% range since December. Odds of a hike later this month jumped after Warsh’s remarks at Jackson Hole, and again on Monday following renewed U.S. strikes on Iran and another rise in the interest rate investors demand to hold long-term U.S. government debt.
Three of the Fed’s 12 voting policymakers were ready to raise rates at the July 28-29 meeting and dissented against the decision to leave them unchanged.
Before its next meeting, the Fed will receive closely watched job and consumer inflation data for August — important information, but an arguably thin base for Warsh, who has discouraged focusing on individual data points, to justify steering away from a rate hike after he said last week that the Fed would “have work to do” if it was not confident that underlying inflation is moving to the 2% target.
Analysts generally credited the speech for clarifying that the Fed would use interest rates as the main weapon against rising prices.
Warsh’s remarks “untangled much of the ambiguity left by his July press conference,” Seema Shah, chief global strategist at Principal Asset Management, wrote after the Jackson Hole speech. Shah had called Warsh’s July 29 post-meeting press conference “one of the most confusing … in recent memory” and said that it “raised questions about the consistency of the policy message” since the Fed chief had talked tough about inflation without saying what he would do about it.
IN THE SHADOW OF THE MIDTERMS
With higher rates now on the table, Warsh will have to either follow through this month with a rate increase weeks before the U.S. midterm elections, or risk being branded as inconsistent. The Fed also meets in late October, close to the election day, and closes out the year with a meeting in December.
Fed officials are adamant that election schedules do not factor into the policymaking process. But a rate hike this month or next could still be a difficult step, given Trump’s expectations and the president’s animosity towards the Fed.
When the central bank cut interest rates in September of 2024, members of the Trump campaign roundly criticized it as a political move by policymakers, including then-Fed chief Jerome Powell, to boost the Democratic Party’s chances in the November presidential election.
The headwinds for Trump’s fellow Republicans going into the upcoming November 3 vote are considerable, with the president’s approval rating stuck at the lowest level of his career and voters constantly reminded of his failure to deliver on a promise to lower the cost of living.
The average price of gasoline in the U.S. is still above $4 a gallon, or about 40% higher than it was before the start of the U.S.-Israeli war with Iran in late February, and the average rate on a 30-year fixed-rate home mortgage has risen by more than half a percentage point in the last six months. Government debt yields, meanwhile, have been grinding higher to 20-year highs under Trump’s watch.
The White House and Republican allies now worry a move by the Warsh-led Fed to lift borrowing costs would give Democrats one more weapon in their battle to wrest control of Congress and diminish Trump’s power in the last two years of his second term in the White House.
‘SOME DEMAND EROSION’
A decision to hold rates steady again, however, risks breaking a central bank taboo against not following up words with appropriate action.
The challenge of staying consistent over time is one of the reasons to avoid “forward guidance,” which Warsh argues ties the hands of policymakers and sets public expectations that may have to be changed. But ignoring guidance altogether has its own risk, with economic researchers arguing that the optimal approach is to avoid binding promises, while providing enough information and follow-up action that the public sees the central bank as committed to its inflation target.
Warsh has arguments to push for a delay.
There is still reason to think inflation will slow without a rate hike, and Warsh should not ignore the risk of a slowdown in consumer spending at a time of rising prices, said Dana Peterson, chief economist for the Conference Board, a trade group for major corporations.
“We believe the Fed can hold,” Peterson said. “We are starting to see some demand erosion.”
In addition, the detailed read on inflation that Warsh gave at Jackson Hole focused on a particular measure that will not be updated until after this month’s meeting — the share of items in the Personal Consumption Expenditures Price Index rising more than 3% annually. A drop in that statistic could bolster arguments that “disinflation” is still proceeding despite ongoing oil price and geopolitical shocks. In addition, an update later this month in how the PCE is calculated is expected to revise inflation estimates lower.
But absent a sharp collapse in coming employment and Consumer Price Index reports, markets are poised for a rate hike, even if there are compelling reasons to wait, said Mike Sanders, a portfolio manager and head of fixed income with Madison Investments.
The decision “is not a slam dunk. It is a coin flip,” Sanders said. While delaying “may be 100% right, you would question his hawkish commentary” from then on if the Fed does keep rates on hold.
“My first reaction would be that he is trying to make every excuse not to raise interest rates,” Sanders said.
(Reporting by Howard Schneider; Additional reporting by Trevor Hunnicutt; Editing by Paul Simao)