Fed Poised for First Warsh-Era Rate Hike as Inflation, Oil Surge Intensify Pressure

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The Federal Reserve enters its September meeting with markets heavily expecting its first interest-rate increase under Chairman Kevin Warsh as hotter inflation, oil above $100 a barrel and the central bank’s own price-stability commitments strengthen the case for tighter policy.

By yourNEWS Media Newsroom.

The Federal Reserve appears increasingly positioned to raise interest rates Wednesday for the first time under Chairman Kevin Warsh, after unexpectedly firm inflation and oil prices above $100 a barrel sharply strengthened the case for additional monetary tightening.

Policymakers begin their two-day meeting Tuesday and are scheduled to announce their decision at 2 p.m. EDT Wednesday. Financial markets are heavily pricing in a quarter-percentage-point increase that would lift the federal funds target range to 3.75% to 4%.

Such a move would mark Warsh’s first rate increase since taking control of the Fed’s rate-setting committee in May and would come after months in which he has resisted providing explicit guidance about the future path of monetary policy.

That preference could become increasingly difficult to maintain if policymakers raise rates and simultaneously release projections suggesting additional tightening may be necessary.

“Warsh will also need to walk a fine line in his remarks if he still aims to provide no forward guidance,” TD Securities economist Oscar Munoz wrote. “If the Fed decides to tighten policy, he will certainly be asked about future rate hikes. It is fairly clear to us that more tightening would be in the pipeline if the Fed goes the hiking route in September. It will be interesting to see how the chairman goes through that balancing act.”

The policy decision also carries a political dimension.

President Donald Trump selected Warsh while publicly pressing for lower interest rates. Trump has so far directed criticism toward other Federal Reserve policymakers rather than Warsh, referring to some central bankers as “political.”

A rate increase would nevertheless arrive less than two months before November’s midterm elections, when Republicans will be defending narrow congressional majorities. The Federal Reserve operates independently in setting monetary policy, with its decisions centered on its statutory economic responsibilities rather than electoral considerations.

The case for a September increase has changed markedly in a matter of days.

As recently as last week, economists and policymakers remained divided over whether inflation was cooling sufficiently to justify leaving rates unchanged. A Sept. 9 Reuters poll found most economists then expected the Fed to hold steady, before subsequent inflation data shifted expectations toward a hike.

Fed Gov. Christopher Waller had argued for patience earlier this month.

“Give disinflation a chance,” Waller said at a Reuters NEXT event, pointing to softer inflation readings in June and July.

New York Fed President John Williams likewise expressed caution.

“I think that we have to wait and see,” Williams said earlier this month.

The August inflation report complicated that argument.

The Consumer Price Index rose 0.4% in August after increasing 0.1% in July, while prices excluding food and energy climbed 0.3% for the month. Core prices were 2.4% higher than a year earlier, remaining above the Fed’s 2% inflation objective.

The monthly core increase was significantly stronger than a pace consistent with sustained 2% inflation, giving policymakers fresh evidence that underlying price pressures may not be easing quickly enough.

The report may also strengthen the position of policymakers who had already favored tighter policy.

Cleveland Fed President Beth Hammack, Dallas Fed President Lorie Logan and Minneapolis Fed President Neel Kashkari dissented when policymakers held rates steady in July, believing an increase was appropriate. Other Fed officials have indicated that they would favor tightening if evidence of renewed disinflation did not emerge soon.

Warsh established his own threshold in an August speech at the Federal Reserve’s annual symposium in Jackson Hole, Wyoming.

“We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do,” Warsh said.

He also placed responsibility for maintaining price stability squarely on the central bank, while emphasizing the importance of market-based measures of inflation expectations.

The August data now leave policymakers evaluating whether the economy is meeting Warsh’s “clearly and at sufficient speed” standard.

Oil has added another complication.

Crude prices have climbed above $100 per barrel amid renewed Middle East hostilities, creating the possibility that higher energy expenses will feed into transportation, production and consumer prices. August’s CPI report already showed energy prices rising 2.1% for the month and 16.3% over the previous year, while gasoline climbed 3.9% in August.

Those developments have contributed to a dramatic shift in market expectations. Reuters reported Monday that most economists surveyed now expect a quarter-point increase Wednesday, reversing the hold-rate consensus that prevailed only days earlier.

JPMorgan economist Michael Feroli expects the Fed to increase rates but characterized the decision as less certain than market pricing suggests.

“At the end of the day, the chair’s repeated stern warnings on inflation intolerance risk institutional credibility absent some action to back it up,” Feroli said, while describing the decision as a “closer call” than the roughly 85% probability previously reflected in futures markets.

Scotiabank economist Derek Holt said he believes raising rates now would be a mistake but nevertheless expects policymakers to do so, in part because of Warsh’s emphasis on financial-market signals.

“Chair Warsh has probably boxed himself in with his high deference to markets,” Holt said. “If you don’t hike when it’s priced, then when?”

Warsh could still guide policymakers toward leaving rates unchanged. Economists note that members of the Federal Open Market Committee frequently give substantial weight to a chair’s preferred policy direction, particularly early in a chairman’s tenure.

But several factors now complicate a decision to hold: August inflation was hotter than anticipated, Warsh has repeatedly emphasized the Fed’s responsibility for price stability, and elevated oil prices could keep inflationary pressure alive if Middle East hostilities persist.

Warsh told central bankers at Jackson Hole that stable inflation expectations should not be taken for granted and that the Fed must ensure they remain anchored.

If policymakers raise rates, attention will immediately turn to whether Wednesday’s economic projections suggest another increase later this year.

That could force Warsh to confront the forward-guidance question he has generally sought to avoid. A rate increase accompanied by projections for further tightening would naturally invite questions about what economic conditions would trigger the next move.

EY-Parthenon economist Gregory Daco expects policymakers who recently favored patience to support an increase after the latest inflation data.

“We think Waller and Williams will argue in favor of a rate hike on the basis that the ‘speed’ of the disinflationary process is not satisfactory,” Daco wrote. “With only one or two dissents favoring a hold, Chairman Warsh will likely use the cover of the majority to lead from behind and also vote for a hike.”

Whatever policymakers decide, Wednesday’s meeting represents the first major test of Warsh’s monetary-policy leadership.

The chairman has repeatedly said the central bank must deliver price stability while avoiding commitments about where rates will move next. With inflation proving more persistent than expected, energy prices surging and financial markets now positioned heavily for tighter policy, those two objectives may become considerably harder to reconcile.