Kevin Warsh leads the first rate hike at the Federal Reserve, ignoring pressure from Trump

US President Donald Trump did not succeed in pushing the Federal Reserve to reduce borrowing costs as he had hoped, as central bank head Kevin Warsh, less than four months after assuming office, led the first interest rate hike in 3 years, a strong indication that the battle to curb inflation may be longer than the markets expected.

The Fed’s decision to raise the interest rate by a quarter of a percentage point, unanimously agreed upon by the twelve members of the Open Market Committee, seemed to be more than just an adjustment to the borrowing rate. It carried a clear message about the shift in the central bank's stance towards inflation, especially with the continued rise in energy prices and the repercussions of the war in the Middle East.

The Financial Times said that Warsh, who was chosen by Trump to head the central bank months after the president criticized his predecessor Jerome Powell for not lowering interest rates as quickly as he wanted, provided the strongest indication yet of his willingness to resist pressure from the White House, after he succeeded in rallying the twelve members of the Open Market Committee behind the decision to raise interest rates.

“Inflation is too high, for too long,” Warsh said after the decision, adding that it would be difficult to describe current interest levels as high enough to limit economic activity.

This message reinforces the conclusion of the Wall Street Journal that Warsh took a more hawkish approach in his last meeting, after indicating that interest rates, even after the recent increase, still do not impose sufficient restrictions on the economy.

Wider strictness than warsh

The transformation is not limited to the head of the Federal Reserve. The economic forecasts of the bank members showed that 16 out of 18 officials expect at least one increase in the interest rate before the end of the year, while four of them expect two additional increases, while only two officials expect to keep the interest rate unchanged until the end of 2026.

According to the Financial Times, Robert Sokin, chief US economist at BGIM, said that his estimate indicates that Warsh is the “most hawkish” among the members of the Open Market Committee, or at least among the most hawkish on it.

In reading the Wall Street Journal, the latest increase may not be a one-time adjustment, but rather the beginning of a more stringent path, especially after Warsh indicated that raising interest removed a “dose of monetary easing.” In the language of central banks, this means that monetary policy has not yet reached a level that would restrict economic activity.

Short-term US Treasury bond yields, which are highly sensitive to interest expectations, also rose to their highest levels in more than two years following the decision.

The energy shock changes the Fed’s calculations

The central bank's shift becomes more important in light of its changing assessment of the repercussions of rising energy prices. Warsh pointed to geopolitical developments and the energy shock among the factors that led to the decision to raise interest rates, explaining that bank officials changed their assessment of the path of these shocks, and no longer viewed them as a temporary disturbance that could be waited for to fade away.

Here lies one of the main points in the Wall Street Journal's analysis: oil prices, which had declined for a period, rose again to approach $100 per barrel, while the prices of diesel and other refined products rose, making it more difficult to assume that energy-related inflation will automatically subside.

Michael Gabbin, chief US economist at Morgan Stanley, said that the combination of the Fed’s belief that monetary policy is not restrictive enough, and the continued rise in oil, means that the bank “still has some work to do.”

The Federal Reserve also raised its expectations for inflation and the neutral interest rate, which is the level that neither accelerates nor slows down the economy. According to the Wall Street Journal, these amendments mean that the recent interest hike came in part to keep pace with the bank’s changing estimates of the economy, and not necessarily to move to a more stringent monetary position to the same extent.

Trump: The interest must be 1% or less

The decision came in direct confrontation with Trump's demands to reduce borrowing costs. The US President said on his “Truth Social” platform that interest rates in the United States “should be 1 percent or less,” based on his belief that the United States has the best creditworthiness in the world.

Later, Trump said that he trusted Warsh, but he held the Fed Council responsible for the decision, describing the Council as “hostile.” He told reporters: “I told Kevin, ‘You can vote with the council, because that won’t change anything.’”

The Financial Times notes that Trump's statements seemed closer to an acknowledgment of his inability to change the course of the central bank, despite his long personal relationship with Warash.

As for Warsh, he avoided commenting on his conversations with the president, and said that the decision to raise interest was a “sober, serious, and responsible” decision, and that the bank had been preparing for it and studying it since his arrival at the Federal Reserve in May.

The inflation battle is not over

These developments come at a time when inflation is still well above the Federal Reserve's target of 2 percent. According to the Financial Times, the personal consumption expenditures price index, the central bank’s preferred measure, reached 3.7 percent, nearly double the target.

Claudia Sahm, chief economist at New Century Advisors and a former official at the Federal Reserve, believes that customs duties and the conflict in the Middle East have contributed to increasing inflationary pressures. On the other hand, Kush Desai, Trump's spokesman for economic affairs, said that the continued inflation is almost entirely due to a shock in energy supplies and high oil prices in the Middle East.

While raising interest cannot directly reduce oil prices, the Fed faces a more complex dilemma: allowing inflation to continue for a long period may entrench it in the expectations of companies and households, while tightening monetary policy for a longer period may put pressure on demand, markets, and economic activity.

Markets are awaiting the next step

Warsh did not provide a decisive indication about whether the Federal Reserve would raise interest rates again at its next meeting in late October, leaving the markets to estimate the next path based on inflation and economic activity data.

But markets are pricing in at least one increase before the end of the year, while short-term bond yields rose after the meeting, after investors interpreted Warsh's comments as more hawkish than expected.

Analysts believe that Wednesday's decision restored some confidence in the independence of the Federal Reserve, after the previous period raised questions about Warsh's ability to resist political pressure.

Diane Swank, chief economist at KPMG, said that the Fed’s credibility has been put to the test after years of high inflation, considering that Warsh “did his duty” at a crucial moment.

But the road ahead for the central bank is still fraught with risks. The rise in Treasury bond yields to about 5 percent, and mortgage rates approaching 7 percent, have begun to put pressure on housing, car purchases, and discretionary spending, at a time when companies outside the energy and artificial intelligence sectors are facing a slowdown in sales and a rise in costs, according to what was reported by the Wall Street Journal.

Conversely, keeping rates low in the face of persistent inflation may allow high price expectations to take hold.

Thus, Warsh finds himself facing a different equation than what Trump expected when he was chosen to head the Federal Reserve. Rising energy prices, war, and customs duties have brought inflation back to the forefront of the central bank’s accounts, while the recent increase in interest rates has become, according to the Wall Street Journal and Financial Times, a potential starting point for a longer tightening path, not just a single step.