Oil prices have soared due to the Iran war, and there are concerns about a resurgence of inflation. That makes Fed officials more likely to suspend the central bank’s recent efforts to lower interest rates, or even raise them.
But that’s the Fed as we know it now. The central bank is likely to soon have a new leader with a different view of inflation. If Kevin Warsh is confirmed by the Senate, he will almost certainly be reluctant to cut interest rates despite soaring oil prices.
Warsh is President Donald Trump’s candidate to become the next Federal Reserve Chairman. He will replace Jerome Powell, whose term expires on May 15th. Trump formally sent Warsh’s nomination to the Senate on Wednesday.
Prior to the selection, Mr. Warsh said he believed interest rates should be lower than the current federal funds rate (3.5% to 3.75%), and Mr. Trump made it clear that he chose Mr. Warsh because of their shared desire for low interest rates.
Soaring inflation could pose a difficult challenge for candidates who need to navigate Senate confirmation while maintaining the president’s support.
barrel brent crude oil It sold for about $72.50 on Friday, before the U.S.-Israeli military operation unfolded. By Wednesday evening, it was trading above $82. Gasoline prices are rising, raising concerns about higher prices across the economy as Republicans seek to drive an affordable message in the midterm elections.
Daleep Singh, chief global economist at asset manager PGIM Fixed Income, said in a note to clients late Tuesday that if oil prices continue to rise by $10 a barrel, the Fed’s so-called core inflation measure could rise by as much as a tenth of a percentage point.
Singh, who advised then-President Joe Biden on national security, wrote that in that scenario, “the Powell Fed’s most likely response would be to justify an extended suspension.”
These issues can be academic questions. The Trump administration has said it has a plan to reverse the rise in oil prices, and the war could be over by the time Warsh takes office in May or June.
Fed members are different from Warsh.
Some of the Fed’s voting members have said they are concerned about how Iran could harm the economic outlook, more so than Chairman Warsh expected.
“We were pretty confident until a few days ago,” Minneapolis Fed President Neel Kashkari said Tuesday at a Bloomberg event in New York. He said more data needs to be seen to determine what interest rates will be.
New York Fed President Williams said Tuesday at an event in Washington that he wants to see “how persistent this is.”
This is business as usual for the Powell Fed. We have paid close attention to the broader impact of the conflict on oil prices and inflation. In 2022, after Russian President Vladimir Putin launched an invasion of Ukraine, Powell warned that “soaring oil prices” were “creating further upward pressure on inflation.”
Warsh takes a different view. “Fed leadership blamed President Putin for inflation,” Warsh told Fox Business’ Larry Kudlow in July.
The Fed’s “core theory on inflation” is “misunderstood,” Warsh told Barron’s in the fall. The agency is constantly trying to fine-tune its assessment of how supply and demand affect prices. But in Warsh’s view, the post-COVID-19 inflation spike is clear evidence that the Fed is focusing on the wrong factors.
“Essentially, I think inflation occurs when the government spends too much and prints too much,” Warsh said at the time.
In that worldview, small fluctuations in oil prices don’t matter much. He believes that by shedding some of the $6.5 trillion in financial assets the Fed has acquired in recent years and restoring general confidence in the Fed’s credibility, he can lower the long-term interest rates that matter most to consumers.
Warsh also expects advances in artificial intelligence to increase productivity in the economy, and believes rate hikes would put those gains at risk.
The Fed declined to comment. Warsh has not spoken publicly since President Trump announced him as his nominee on January 30. Warsh declined to comment for this story.
The Fed chair only has one vote out of more than a dozen members on the rate-setting committee, but opinions that disagree with him are rare.
Although the Fed was designed by Congress to have no political influence, the president has influence over who is nominated. President Trump has argued that interest rates should be below 1%.
Warsh’s theory of inflation is designed to essentially make a perfect case for this reduction in the economy unless something changes dramatically. Even if an all-out air war with the world’s major oil-producing countries occurs, the situation will not change.
