The Warsh Era Begins, Markets Ready for “Higher for Longer”
The Federal Reserve is entering a new leadership phase with Kevin Warsh soon to be sworn in as chairman, ending the Jerome Powell era marked by prolonged friction with the White House, a global pandemic, and a battle against high inflation. Powell will remain as chairman and interim chairman until Warsh is officially sworn in, opening a new chapter in the central bank's relationship with US President Donald Trump.
Although Trump wants to cut interest rates, Warsh potentially faces the same hurdle as his predecessor: inflation drifting further away from the 2% target. Markets even believe Warsh could be forced to raise rates as early as January, reflecting expectations that the “tighter for longer” policy is not yet over.
On the inflation front, several factors are said to be driving price pressures upward: the lingering impact of import tariffs, the surge in oil prices during the US-Israel war against Iran, and continued strong spending and investment. The “disinflationary” trend that had developed recently has reversed following the shock of tariffs and energy costs, leading some Fed officials to believe that price pressures are building again.
The Fed's second mandate—employment—is also a source of tension. So far, the unemployment rate has remained at 4.3%, relatively low historically, so the urgency for support through interest rate cuts is seen as less strong than when the job market is weakening. Proponents of a cut argue that the labor market is more fragile than it appears and is at risk of a rapid rise in unemployment, but officials' recent focus has tended to shift back to inflation.
Warsh also inherits a significant balance sheet issue. The Fed's portfolio of approximately US$6.7 trillion—primarily Treasury and mortgage-backed securities—is a legacy of crisis-era easing like the pandemic, as well as part of its short-term interest rate management toolkit. Warsh is expected to explore regulatory and policy changes to shrink the balance sheet, but the process could be lengthy and initial results limited. A shrinking balance sheet also risks adding upward pressure on already rising long-term interest rates, impacting the cost of credit like mortgages.
Regarding its policy rate, the Fed has held a range of 3.5%–3.75% since December and considers the current stance to be somewhat restrictive—suppressing inflation without driving a sharp spike in unemployment. However, some policymakers are beginning to favor more hawkish language in the statement, signaling that a rate hike could be just as likely as a cut. If it strengthens ahead of Warsh's first meeting in June, the initial challenge will be managing market expectations while also confronting Trump with a potential "tone shift" since the first meeting.
Beyond near-term decisions, the Warsh-era debate is expected to shift to structural issues: the impact of AI on productivity and the labor market, as well as demographic changes—population aging and declining immigration—that are affecting economic capacity and wage pressures. The market will be watching for three things: whether inflation continues to widen, whether the committee moves to language that opens the door to a hike, and how aggressively Warsh pushes his balance sheet reduction agenda without raising long-term interest rates further. (arl)*
Source: Newsmaker.id
