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Balancing act for new Fed chair: Taming inflation amid rate-cut pressures

As Kevin Warsh steps up to lead the world鈥檚 most powerful central bank as chair of the Federal Reserve, he faces two formidable forces: the dragon of inflation and pressure from President Donald Trump.

It鈥檚 a stark choice. Taming inflation would mean keeping interest rates high, perhaps even raising them. Caving to the president would mean lowering rates.

The consensus among market analysts is that Mr. Warsh, as the new Fed chair, will address the dragon and ignore the president.

Consumers, homebuyers, and investors are watching closely. They all have a stake in the decision Mr. Warsh, a former Fed governor, Morgan Stanley executive, and economic adviser to President George W. Bush, makes.

鈥淗e鈥檚 coming in at a very interesting time, because right now we鈥檙e finding out that inflation is a lot more than a lot of people thought it would be,鈥� says Michael Bordo, an emeritus economic historian at Rutgers University in New Brunswick, New Jersey, and visiting fellow at the Hoover Institution. 鈥淚 don鈥檛 see him making any radical changes.鈥�

Wall Street appears to agree.

鈥淲e no longer expect the Fed to cut rates this year,鈥� Bank of America Securities said in a to investors. The investment firm, like many others, now expects those cuts to come next summer or fall, at the earliest.

The reason is simple: Inflation is now roaring while the labor market remains resilient and may be gaining steam.

The loudest inflation roars came this week. On Tuesday, the Department of Labor that the consumer price index rose 0.6% in April and 3.8% over the past year. That鈥檚 the highest jump in inflation in and well above the Fed鈥檚 2% target.

On Wednesday, the Labor Department released even scarier numbers at the wholesale level. Wholesale inflation 鈥� which often hints at rising consumer prices later 鈥� rose a whopping 1.4% last month, the in four years. Over the past year, the index was up 6%.

Mr. Trump鈥檚 tariffs and the Iran war have raised the cost of everyday items, including many imported goods, for Americans. To curb inflation and cool the economy, the Fed raises interest rates. But that shift can make home mortgages more expensive. Alternatively, when the economy is in recession, the Fed lowers interest rates to spur economic activity.

War and inflation

The president has insisted that depriving Iran of a nuclear weapon is a higher priority than any temporary financial impact on consumers.

When asked by a reporter on Tuesday how much inflation鈥檚 impact on Americans might be influencing his pursuit of a deal with Iran, Mr. Trump , 鈥淚 don鈥檛 think about Americans鈥� financial situation. I don鈥檛 think about anybody. I think about one thing: We cannot let Iran have a nuclear weapon.鈥�

Mr. Warsh, by contrast, must be laser-focused on Americans鈥� finances. In his first stint as a Fed governor, he was viewed as an inflation hawk and served as a key adviser to then-Chair Ben Bernanke. He also served as a liaison with Wall Street during the 2008-09 financial crisis. But he broke with Mr. Bernanke and resigned his post in 2011 over the Fed鈥檚 move to buy $600 billion in U.S. Treasury debt to stimulate the economy.

Lately, Mr. Warsh has been talking about how productivity gains from artificial intelligence could allow for lower interest rates.

Because he oversees the Fed staff that develops policy options for the Federal Open Market Committee (FOMC), which ultimately sets the interest rates, Mr. Warsh now will have more influence over monetary policy than he did as a Fed governor, writes Sarah Binder, at George Washington University and co-author of the 2017 book 鈥淭he Myth of Independence: How Congress Governs the Federal Reserve,鈥� in an email.

But it鈥檚 the vote of the 鈥� including seven Fed governors 鈥� that ultimately sets those rates. Recent comments from Fed governors, including those traditionally more inclined to cut rates, suggest the committee is unlikely to reduce rates until inflation is reined in.

Reshaping the Fed balance sheet?

Another area Mr. Warsh wants to reform is what is often called the Fed鈥檚 鈥渂alance sheet.鈥� This includes the assets the central bank purchases and holds, such as government securities like Treasury bonds and mortgage-backed securities, which have increased tenfold since the financial crisis and the pandemic, peaking at nearly $9 trillion. The Fed made those massive purchases, a tactic known as quantitative easing, to buoy the economy during the twin crises.

Under the direction of outgoing Fed Chair Jerome Powell, who will stay on as Fed governor, the Fed has reduced its balance sheet by about a quarter, to about $6.5 trillion. Mr. Warsh says he wants to shrink the balance sheet more quickly because, in his view, it distorts markets and makes them overly dependent on the central bank during crises.

Whether he can pull that off is another matter. Many economists have come to believe that a more active Fed 鈥� with a bigger balance sheet 鈥� is a plus for the economy. Mr. Warsh would have to convince other Fed governors to go along. And the threat of moving too quickly could cause liquidity problems for banks, sparking a bond crisis, as happened in 2019.

鈥淚 don鈥檛 think he can snap his fingers and just begin to sell some of the term Treasurys that sit on the Fed鈥檚 balance sheet,鈥� says Mark Spindel, founder of Potomac River Capital, a Washington-based investment firm, and co-author of 鈥淭he Myth of Independence鈥� with Dr. Binder, of George Washington University.

Besides potential opposition from some of the seven Fed governors, he adds, 鈥渢he eighth governor in the room is always the bond market. And so, to the extent he risks his and the institution鈥檚 credibility, the bond market has a way of making that really painful, really quickly.鈥�

Mr. Warsh also hopes to change the way the Fed measures inflation and how it communicates its thinking to the public. These moves may change how the central bank operates, but are unlikely to redirect current policy anytime soon, analysts say.

鈥淭he overall inflation picture, no matter how you look at it, is not screaming for a rate cut right now,鈥� Mr. Spindel says.

And if the new chair does change the way the Fed communicates 鈥� eliminating what鈥檚 sometimes called the 鈥渄ot plot,鈥� which charts where each FOMC member sees inflation going 鈥� he will have to come up with some other means of signaling Fed intentions, argues Dr. Bordo of Rutgers.

鈥淵ou need to be transparent to be credible,鈥� he says. 鈥淎nd credibility鈥檚 the most important thing that a central bank has.鈥�