Federal Reserve Chair Kevin Warsh is poised to raise interest rates for the first time in three years, as economists anticipate policymakers will align with market expectations rather than President Donald Trump's calls for lower or unchanged rates. The decision is expected Wednesday.
Warsh's recent actions and statements suggest a rate hike is likely. A high-profile speech last month warned that inflation remained above the Fed's 2% target, indicating a need for higher borrowing costs. This stance was further reinforced by a report showing inflation is still stubbornly high, solidifying investors' expectations.
This situation presents a dilemma for Warsh, who, shortly after becoming chair, also faced opposing forces between market expectations and political pressure. In late July, the Fed left its key rate unchanged despite hawkish rhetoric on inflation. This decision led to an acceleration in longer-term interest rates, with the 10-year Treasury bond rate reaching 5% for the first time in three years, pushing mortgage rates higher as well.
If the Fed does not increase its key rate, economists warn it could lead to a repeat of the market reaction seen in July. When inflation is expected to remain high, investors demand higher interest rates on bonds to compensate.
Diane Swonk, chief economist at KPMG, explained that a rate hike now could potentially lower long-term rates later by restoring faith in the Fed's 2% inflation target. Conversely, failing to act could cause markets to tighten independently through higher mortgage and business borrowing costs.
A quarter-point rate increase would bring the Fed’s benchmark rate to approximately 3.9%.
During his presidential campaign, Trump advocated for lower interest rates. However, since Warsh took office, geopolitical events, including the Iran war, have significantly increased gas prices, contributing to inflation reaching 3.7% in July. Core inflation, excluding food and energy, also rose.
Choosing not to raise rates could be interpreted as yielding to White House pressure, potentially damaging the Fed's credibility with financial markets.
Kristin Forbes, an economics professor at MIT and former Bank of England policymaker, noted that Warsh is concerned about his legacy and that Fed chairs who succumb to political pressure historically face criticism.
Trump has previously criticized former Fed Chair Jerome Powell for not lowering rates quickly enough, even leading to a Justice Department investigation over Powell's congressional testimony.
When asked about Trump's potential reaction to a rate hike, Kevin Hassett, Trump's top economic adviser, stated that while Trump might not be pleased, he would prioritize defending the Fed's independence.
The Fed's decision on Wednesday will be accompanied by quarterly economic projections, offering insights into the potential future direction of interest rates.
Historically, the Fed typically implements a series of rate hikes or cuts. However, there is a precedent for a single increase, as seen in March 1997, when then-Chair Alan Greenspan raised rates by a quarter-point. The Fed subsequently held rates steady following an Asian financial crisis before cutting them later in 1998 as the crisis worsened.
Wall Street investors are currently anticipating three rate hikes, with additional increases expected in December and March. However, economists suggest that if future inflation data shows cooling price increases, the Fed might reconsider further hikes.