Kevin Warsh will face a searing credibility test in his first meeting as the new chair of the Federal Reserve on Wednesday as he seeks to balance his stated receptiveness to rate cuts with the recent rise in inflation.
Investors and policymakers will gain insight into his approach when the Federal Open Market Committee releases its policy statement and Summary of Economic Projections, followed by Warsh’s remarks afterward.
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We expect the Fed to keep the federal funds rate in a range between 3.5% and 3.75%, but we expect the FOMC to remove the easing bias from its policy statement.
As the labor market has firmed and inflation continued the rise that began before the war, one should anticipate a hawkish hold out of the committee featuring a change in the language of the text that signals the likely direction of the next policy move.
This means that the FOMC will take out language on “additional adjustments” from the policy paragraph and will move in coming meetings to add language to the effect of “determine the extent of additional policy firming” in response to a broadening out of inflation.
The median dot in the dot plot will feature no rate cuts or rate hikes this year with next year likely featuring one rate hike with the possibility of none.
But the primary focus of Wednesday’s meeting will be on Warsh’s response to what we expect will be aggressive questioning of his assessment of the risk surrounding rising inflation, which has been above the Fed’s 2% target for five years.
With both the consumer price index and, more important, the personal consumption expenditures index standing above the 3.75% upper boundary of the federal funds rate, the case for further accommodation through monetary policy will simply not pass the smell test with financial markets.
Warsh recently pointed to the Dallas Fed’s trimmed one-year mean, which stands at 2.35%, as a better inflation metric than the PCE, the Fed’s preferred inflation gauge.
That view has one glaring weakness: It removes more than 50% of the prices that make up the PCE. So when one encounters significant skews in pricing, the trimmed one-year mean can fail to capture a potential shift in inflation regimes.
In our estimation that is exactly what happened following the pandemic shocks, when the Fed was late to respond to rising prices, and it may be occurring amid the recent damage to oil production facilities and shipping in the Middle East.
Any attempt by Warsh to play down the broadening out of inflation may be interpreted by investors as the latest sign that he is soft on inflation.
The supply shock unleashed by the war is still working its way through the economy, and the buildout of artificial intelligence infrastructure is creating its own supply chain challenges. Put another way, we have not yet reached a peak in inflation.
Moreover, any sign of dovishness from the Fed chair will result in a powerful split-screen event in which Warsh speaks as interest rates simultaneously rise.
We expect that Warsh will not contribute to the “dot plot” interest rate forecast and that the committee will vote unanimously in favor of holding rates steady.
The Summary of Economic Projections will feature a downward revision in 2026 gross domestic product and an increase in the PCE and core PCE inflation forecasts for this year. We do not anticipate any change in the unemployment rate forecast.
The takeaway
The FOMC statement will feature changes in the text that imply a move away from a bias toward easing in favor of a neutral stance. Down the road, this stance might shift toward a tightening bias as supply shocks continue to take a toll.
It all puts Warsh in a difficult position. He campaigned for the job with a promise of rate cuts, which the executive branch has called for. But the recent rise in prices, and the broadening out of inflation, make any rate cuts difficult. It’s this quandary that will define the start of the Warsh era at the Fed.
