A penny for Kevin Warsh’s thoughts. The US Federal Reserve chairman faces what on paper looks to be a fairly straightforward decision on whether to increase interest rates this week. In practice it will be anything but.
The economic data suggests it would be prudent for Warsh to follow the European Central Bank with a rate rise on Wednesday. Core inflation, which strips out volatile items like energy and food, rose more than had been expected in August compared to a month earlier. That is a sign that inflation is beginning to weave its way into the wider economy.
Meanwhile, 10 days ago the US non-farm payrolls report – essentially the nation’s jobs report – showed the US economy added 162,000 jobs in August. That was far ahead of expectations, showing the strength of the underlying economy.
It’s an oversimplification to say the Fed would only look at those two data points, but they would suggest that a rate hike is necessary to throttle inflation. They would also suggest that the wider economy is strong enough to tolerate an increase without being forced into contracting for now.
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Add in the fact that markets reacted hawkishly to last week’s inflation report and have priced in a rate hike before year end, along with the fact that Warsh has faced a credibility problem since he flubbed his press conference after the Fed’s last interest rate decision in July, and it would seem he almost has to hike this week.
That, though, ignores the fact that US president Donald Trump is publicly calling for a rate cut and made moves to undermine Warsh’s predecessor Jay Powell while also seeking to fire Fed governor Lisa Cook.
So Warsh faces a balancing act.
Does he increase rates and risk the ire of Trump and all that comes with that? Or does he try to hold steady and risk the ire of the market? The yield on 10-year Treasuries (as US bonds are known), topped 5 per cent for the first time since 2023 on Monday. That implies traders expect inflation to keep rising.
In July, Warsh characterised the Fed as the referee in markets, but in truth it is the key player. Your move, Kevin.
