Warsh Approaching Approval, but Rate Cuts on Hold
Kevin Warsh’s nomination to lead the Federal Reserve appears to be on track for approval. The Senate is set to vote on this matter at 5:30 p.m. on Monday, and it seems likely they will greenlight it.
Interestingly, Warsh is slated for two roles: Fed Governor and Fed Chair. Both nominations need Senate approval since the chair must also hold a governance position. He’s expected to take over the governor’s seat from Stephen Millan, who has not yet given up his position on the board despite outgoing Chairman Jerome Powell’s insistence on retaining his seat.
It’s clear that President Trump wants Warsh to shift away from the current Fed policies, particularly to maintain interest rates as they are and even support significant cuts. However, that economic environment, which Trump advocates for, might not align with what Warsh will encounter.
Last month, three Federal Reserve presidents made their stance clear. Beth Hammack from Cleveland, Neel Kashkari from Minneapolis, and Laurie Logan from Dallas objected to the idea of including language that hinted at a willingness to lower rates in the Federal Open Market Committee’s April meeting—marking the most objections to a single issue since 1992. Their message was crystal clear: the Fed shouldn’t lean towards rate cuts given the current economic landscape.
Strong Job Market Suggests Layoffs Are Unnecessary
The job market gives weight to their argument, with 115,000 new jobs added in April. Private employment saw an increase of 123,000, marking consistent growth for the first time in a year. The unemployment rate held steady at 4.3%, and claims for unemployment benefits have dropped to their lowest level in four decades. The job side of the Fed’s dual mandate seems to be in solid shape.
Moreover, the economy appears to be on a steady growth path. Following a sluggish end to last year and a shaky start in early 2023, the Atlanta Fed’s GDPNow tracker shows a robust figure of 3.7% for the second quarter. Business investment is thriving, fueled by advances in AI and incentives from a recent major economic bill. Retail sales rose 0.7% in March, marking a 4% increase from the previous year—defying the pessimistic sentiment reflected in consumer surveys. The first quarter also saw retail sales grow by 3.7% compared to the same period last year. This isn’t an economy that urgently needs monetary stimulus.
It feels somewhat counterintuitive that, despite businesses doing well, debt interest rates tend to decrease. Stronger financial performance generally leads investors to see less risk, allowing for lower rates. Yet, federal debt doesn’t factor in default risks fully and is more influenced by how markets expect the Fed to act. When investors believe the Fed will lower rates to bolster the labor market, they tend to see declines in long-term Treasury yields. If the Fed feels stable, it will start expecting both rate cuts and hikes.
Meanwhile, inflation is still high, driven partly by a rise in global energy prices. The personal consumption expenditure price index increased to 1.7% in March, which equates to an annualized rate of 8.3%. Compared to a year prior, it’s up 3.5%, marking the highest level since May 2023, largely due to shocks from ongoing conflicts.
On a positive note, the underlying inflation situation looks healthier. The Dallas Fed’s trimmed average PCE inflation rate for March stood at 2.4% on a 12-month basis, with a six-month annualized rate at just 2.2%. Labor costs rose modestly by 1.2% year-over-year in the first quarter, resulting in an annualized increase of only 2.3%.
However, this nuanced view doesn’t help Warsh build broad support for cuts any time soon. Recent comments from the Fed have leaned more hawkish. Officials like Mr. Goolsby and Mr. Mussallem have pushed back against Warsh’s advocacy for cuts, particularly those he believes will foster AI-led productivity. Importantly, Warsh is stepping in for Governor Stephen Millan, who has been a consistently dovish voice, advocating for lower rates, while Governor Christopher Waller has recently adopted a more cautious perspective.
Oil Price Spikes May Not Lead to Inflation
The current oil crisis isn’t necessarily historical inflationary; it could be deflationary since rising gas prices generally reduce consumer spending power. Yet, it’s unclear how well all members of the FOMC grasp this. Many are worried that rising fuel prices may push household inflation expectations upward, supported by consumer sentiment studies like those from the University of Michigan. The Fed believes such inflation expectations can become self-fulfilling, prompting a hawkish approach.
Analysts at Bank of America had initially anticipated a rate cut between September and October, but that now seems postponed until summer 2027. The reasoning is straightforward: ongoing data flow indicates that reductions aren’t feasible at this moment. Current assessments from CME Group’s FedWatch tool suggest that no cuts are expected this year, with a slight 20% chance of a 25-basis-point increase, contrasting with almost no probability a month ago.
President Trump’s economic strategy—tightening labor supplies through immigration control, restructuring trade flows, boosting U.S. manufacturing through tariffs, enhancing business confidence via deregulation, supporting investment through tax cuts, and backing fossil fuel sectors—has resulted in a strong labor market and solid business growth. As a result, rate cuts might be unlikely in the near future. Warsh comes to the Fed advocating for lower rates, but the favorable economic conditions make this task even more challenging.
So, it seems, the president will need to hold off on those rate cuts for the time being.
