When President Donald Trump nominated Kevin Warsh as Federal Reserve Chair at the start of the year, the market was primed for Warsh to push for lower interest rates. Just a few months later, that looks virtually impossible. In fact, investors currently put the odds of at least one rate hike by the end of 2026 at about 60%. Virtually nobody actually expects Warsh to push through a rate cut this year.
That has yet to affect equity prices. The S&P 500 and Nasdaq Composite have soared to new all-time highs as Warsh takes control of the central bank. But the Fed policies under Warsh could lead to a substantial stock market downturn if rates continue to creep higher.
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Will Kevin Warsh end up raising rates?
This isn’t Warsh’s first rodeo at the Fed. He served on the Board of Governors, acting as a voting member of the FOMC, between 2006 and 2011. During his tenure, he opposed maintaining low interest rates and quantitative easing amid the financial crisis, warning that they could lead to high inflation.
It seems he hasn’t changed his attitude since. Warsh criticized his predecessors in his Senate confirmation hearing, saying that they made a terrible policy error in 2021 and 2022 by waiting too long to raise rates. “Once you let inflation take hold in the economy, it’s more expensive and harder to bring it down,” he said.
The best tools the Fed has to keep inflation at bay are to raise the target federal funds rate and sell long-term bonds on its balance sheet. The former will increase short-term rates, while the latter will increase long-term Treasury Bond rates.
Warsh joins the Fed as inflation is spiking. The war in Iran, which led to the closure of the Strait of Hormuz, has sent commodity prices soaring, affecting all sorts of goods and services. The Consumer Price Index reached 3.8% in April, and it could climb to 4.2% for May, according to the Cleveland Fed’s estimate.
The longer the war continues, the worse the problem will get, and the slower prices will recover. It’s just one more in a string of near-constant supply shocks that the U.S. economy has had to absorb over the last six years, putting pressure on the Fed to manage volatile inflation.
Warsh’s bent is toward reducing the Fed’s bond market participation and shrinking its balance sheet. That would allow long-term interest rates to rise. He could offset that with a cut in the target fed funds rate, but that’s not a reasonable course with inflation running hot. Indeed, an interest rate hike is more likely to fit with Warsh’s major concerns with previous policy decisions.
