WASHINGTON, September 16 — Kevin Warsh has been Federal Reserve chair for barely four months, and on Wednesday he faces the first real test of the job: raise the benchmark interest rate, siding with financial markets, or heed President Donald Trump, who wants the Fed to cut rates or leave them unchanged. Economists expect Warsh and his fellow policymakers to side with the markets and deliver a quarter-point increase — the first in three years — pushing the Fed’s key rate to about 3.9%.
A report last week showing inflation is still stubbornly high largely sealed investors’ expectations.
Warsh boxed himself in
Warsh became chair on May 22. Soon after, he delivered tough rhetoric on inflation, but in late July the central bank left its key rate unchanged. After he provided little explanation at a press conference, investors pushed up longer-term interest rates, accelerating a process still ongoing.
This week, the rate on the 10-year Treasury bond reached 5% for the first time in three years, and mortgage rates, which closely follow the 10-year Treasury, have also risen. If the Fed does not hike on Wednesday, it risks a replay of late July, economists say.
Warsh has largely boxed himself in, economists say, after a high-profile speech last month warning that inflation remains too far above the Fed’s 2% target and might require higher borrowing costs to bring it down. “That is the paradox: A hike now could lower long-term rates later,” Diane Swonk, chief economist at KPMG, wrote in an email. “Restore faith in the 2% target, then the inflation premium can fall.
Fail, and markets will tighten instead through higher mortgage rates, business borrowing costs and interest on the debt.”
The political pressure
If the Fed forgoes a hike, it would risk being seen as giving in to pressure from the White House, which could undercut its credibility with financial markets. “Kevin cares about his legacy,” said Kristin Forbes, an economics professor at MIT’s Sloan School and former policymaker at the Bank of England. “And he knows that Fed chairs who follow political pressure instead of the economy do not go down well in the annals of history.” Trump harshly criticized Warsh’s predecessor, Jerome Powell, for not cutting rates quickly enough.
His Justice Department even launched a criminal investigation into Powell over brief testimony he delivered to Congress last year, though that probe was eventually dropped. Kevin Hassett, Trump’s top economic adviser, was asked in an interview with Fox News on Sunday how Trump might react to a rate hike.
“I’m sure he’s not going to be super happy about it, but he will defend the independence of Kevin Warsh above all,” Hassett said. Warsh might also have a measure of protection from the fact that his father-in-law is Ronald Lauder, a friend of Trump’s and a billionaire donor to his campaigns.
What comes next
Even if Warsh decides to support a rate hike, it is not clear how many more will follow. It is unusual for the Fed to change rates just once; typically the central bank embarks on a series of hikes or cuts. There is one precedent for a single hike: In 1997, former chair Alan Greenspan lifted rates by a quarter-point in March of that year.
Yet a financial crisis ignited in Asia that July, prompting the Fed to remain on hold; when the crisis worsened in 1998, the Fed ultimately cut rates three times that fall. For now, Wall Street investors anticipate the Fed will hike three times, with additional increases in December and March.
But Jonathan Pingle, an economist at UBS, said it is possible that if future inflation data showed price increases cooling, the Fed could forgo more hikes. “They don’t have to follow through on that if the data goes their way,” Pingle said. On Wednesday, the Fed will provide some hints about its next moves.
