President Donald Trump tapped Kevin Warsh as his Federal Reserve chair in the hopes of finally securing the lower borrowing costs he has longed for.
The bond market might overrule both of them.
As Warsh takes the helm of the central bank following a White House ceremony on Friday, global bond yields are surging, with the war in Iran pushing up inflation and making interest rate cuts look less and less likely. In the last week, rates on 30-year U.S. government debt at one point touched their highest level since 2007. Investors — and a majority of Fed officials — are now giving real consideration to the idea that the central bank might have to raise rates before the end of the year to keep inflation in check.
“There’s no space for rate cuts” is the message from rising bond yields, said Tim Duy, chief economist at SGH Macro Advisors.
The spike in borrowing costs is already amping up pressure on the new Fed chief as he faces the possibility of both chaos in markets and wrath from the Oval Office. Trump, who mercilessly criticized outgoing Fed Chair Jerome Powell for not cutting rates, has suggested in recent interviews that he might not expect immediate action from Warsh, given the economic fallout from the Middle East conflict. Still, elevated market rates will test his patience, especially as the midterm elections in November approach.
How long of a honeymoon Warsh gets from presidential pressure is one of the key questions facing the new Fed chair, who previously served on the central bank board from 2006 to 2011, a period when he played a role in dealing with the financial crisis.
Warsh, who has previously said productivity gains from artificial intelligence could help stifle inflation and allow rates to come down, on Friday expressed his commitment to the central bank’s mandates of stable prices and maximum employment.
“When we pursue those aims with wisdom and clarity, independence and resolve, inflation can be lower,” he said. “Growth stronger. Real take-home pay higher. And America can be more prosperous.”
Trump, for his part, suggested he intended to be hands-off on Warsh for the time being.
“Honestly, I really mean this … I want Kevin to be totally independent,” he said. “I want him to be independent and just do a great job. Don’t look at me or anybody.”
Still, his praise of Warsh was an implicit caution against too-high rates.
“Thankfully, unlike some of his predecessors, Kevin understands when the economy is booming, that’s a good thing,” he said. “We have some debt we would like to take care of. The way you do that is through growth.”
“We want to stop inflation, but we don’t want to stop greatness,” Trump added.
Warsh’s predecessor, Powell, is sticking around on the Fed board for now, a decision he has attributed to the president’s legal attacks on the central bank. That creates another awkward dynamic for Warsh, though Powell has said he intends to keep a low profile and wants to work constructively with the new chair.
At his final press conference as central bank chief last month, Powell said the institution would want to see energy costs coming down from their peak and tariff-related price spikes fading “before we even thought about reducing rates.”
Oil-related inflation fears are piling onto other trends that are pushing up borrowing costs, including massive budget deficits that have led to a glut of public debt for investors to absorb, forcing governments to offer investors ever-higher yields.
Good news is also contributing to the problem: The artificial intelligence spending boom and robust corporate earnings have increased expectations for healthier growth — a dynamic that also keeps rates higher, as government borrowing competes with other investment options. AI spending has also helped push up software inflation in the short term.
None of these factors seems to be fading quickly, which means the U.S. could be facing just the situation the Trump administration wanted to avoid: higher mortgage rates and higher debt costs for the U.S. government.
Subadra Rajappa, head of U.S. research at Société Générale, described it as “an environment of sticky high interest rates” combined with the possibility of even more debt, given huge bumps in defense spending being proposed by the Trump administration.
“That all adds up over the longer run,” she said.
Stephen Miran, a Fed governor who is departing on Friday because Warsh has replaced him on the central bank’s board, is something of an outlier: Miran, who previously served as Trump’s chief economist, argues the Fed can cut rates because its policy decisions take time to feed through to economic activity, and longer-term trends, such as declining population growth, will help keep inflation tame.
“The market for sure is rapidly changing with respect to the war in Iran, and as that develops, the market will follow,” he said. “Even if the war stays bad for a while, I think the market is a little too enthusiastic about rate hikes relative to where inflation is going and relative to where the labor market is.”
But whether Warsh can convince his colleagues to cut rates at some point this year depends at least in part on the length and severity of the war in Iran, which remains in flux nearly three months into the conflict.
Fed board member Christopher Waller said in remarks earlier Friday that “a rate cut is no more likely in the future than a rate increase” when considering the central bank’s next move, but that his current position is that rates should stay where they are for now.
If higher energy costs weigh on the private sector enough to spur a rise in layoffs, which at this point remain low, the Fed might eventually choose to ease off on the economy. Yet the job market has held up, even exceeding expectations over the last two months.
Inflation, meanwhile, has proven troublesome beyond just the price increases spurred by higher oil prices and tariffs, which could suggest a role for the Fed in the form of rate hikes.
Together, those indicators paint a picture that might make bond investors nervous if the central bank were to cut rates — both because they might register it as a mistake and because it could heighten fears that the Fed is being driven by political pressure from the president rather than decisions guided by what’s best for the economy.
“If you really do make a policy error, and it’s blatant, the market’s going to react,” Duy said. “The data has just stripped [Warsh] of the capacity for a rate cut.”
