Federal Reserve Chair Kevin Warsh is facing increasing pressure to raise interest rates in the coming months, despite expectations that the central bank will hold steady at its upcoming meeting. The confluence of a renewed conflict in the Middle East, which has driven up oil and gas prices, and ongoing trade disputes are contributing to inflationary pressures that officials say can no longer be ignored.
Inflation, as measured by the Fed's preferred metric, has exceeded its 2% target for over five years. Core inflation, which excludes volatile energy and food costs, has been around 3% or higher since 2023. Some Federal Reserve officials have indicated that rate hikes will be necessary if tangible progress on bringing inflation down is not observed soon.
"Unfortunately, inflation does not appear to be headed sustainably back all the way to 2%," said Lorie Logan, president of the Federal Reserve Bank of Dallas and a voting member of the Fed's rate-setting committee. "Modestly higher interest rates would better balance the outlook."
Since assuming the chairmanship in May, Warsh has consistently stated the Fed's commitment to returning inflation to its 2% goal, though he has avoided providing specific forward guidance on the central bank's next steps. In recent congressional testimony, Warsh emphasized that the Fed has "no tolerance" for higher inflation and reiterated the central bank's pledge to "deliver price stability."
These statements, coupled with rising energy prices due to the Iran conflict, have already contributed to higher borrowing costs. The yield on the 10-year Treasury note, a key benchmark for mortgage rates, briefly surpassed 4.7% recently, its highest level in approximately 18 months.
Former Federal Reserve Bank of St. Louis President James Bullard noted that Warsh's rhetoric has been effective in bolstering the Fed's credibility, but added, "markets are going to ask, ‘Well, what have you done for me lately?’ And they're going to demand action."
Other influential figures within the Fed have also voiced concerns. Christopher Waller, a member of the Fed's governing board, stated that "Sternly staring at inflation until it melts before our withering gaze is not an option." He indicated that if core inflation continues to climb, the committee "will need to consider" raising rates "in the near term."
Beth Hammack, president of the Cleveland Fed, has observed an unusual shift, hearing from business leaders who are now advocating for higher rates, a departure from their typical support for lower borrowing costs. She also noted a growing sense of "despair" from consumers struggling with rising costs.
Economists remain divided on the path forward. The latest inflation report showed a notable cooling in core inflation for June, and headline inflation fell sharply as gas prices declined. However, the resumption of hostilities in the Middle East has pushed gas prices back above $4 per gallon nationwide, potentially increasing headline inflation just before the Fed's September meeting.
Vincent Reinhart, chief economist at Dreyfus-Mellon and a former Fed economist, pointed out that higher interest rates can dampen demand and reduce inflation but are less effective in addressing supply disruptions caused by geopolitical events. "The Fed is looking at inflation well above goal, but mostly for reasons that it doesn’t have any influence on," Reinhart said.
During his congressional testimony, Warsh suggested the Fed's role is to prevent specific price increases, such as those for gasoline or technology components, from becoming widespread. The traditional approach would involve raising rates if such broad price increases were evident. However, some analysts believe Warsh may be attempting to manage inflation through strong communication, hoping to avoid actual rate hikes.
"They are hoping and intending to talk the talk without having to walk the walk," said Stephen Douglass, chief economist at NISA Investment Advisors. He anticipates the Fed will not raise rates this year.
Conversely, other economists argue that inflation will not subside without direct intervention from the Fed. Joseph Lavorgna, former chief economist at SMBC Americas, stated, "There has never been a time when inflation gradually moderated without impetus from the Fed. In other words, core inflation is not going to magically slow."