Warsh vows not to ‘waver’ on inflation as divided Fed leaves rates unchanged

The Federal Reserve held interest rates steady on Wednesday, a choice that may intensify questions about how U.S. central bank chief Kevin Warsh will deliver on his commitment to bring inflation back down to the 2% target.

The widely expected decision to leave the benchmark interest rate in the 3.50%-3.75% range drew dissents from three of the 12 members of the policy-setting Federal Open Market Committee who "preferred" a quarter-percentage-point hike at this meeting. Those same three officials - the presidents of the Fed's Cleveland, Dallas and Minneapolis regional banks - had also dissented at Jerome Powell's final meeting as central bank chief in late April. In that case, they favored removing the implied promise of lower rates in the policy statements. Warsh, who took over as head of the Fed in May, has said he has "no tolerance" for inflation that has been running above the central bank's target for more than five years, and up until last month was accelerating as the war in the Middle East pushed up global fuel and food prices, and investment in data centers and other spending tied to artificial intelligence drove up demand. "Inflation remains elevated relative to the Committee's 2% goal," the Fed said in a short policy statement after the end of its latest two-day meeting. It replicated word for word all of the June 17 statement's assessment of the economy.

The Fed noted that economic activity is "expanding at a solid pace," saying, as it did in June, that job gains "have kept pace with the workforce, and the unemployment rate has changed little." Speaking in a press conference after the release of the policy decision, Warsh said, "We've begun a new chapter and we understand that the five-plus years of inflation above-target cannot be cured in nine weeks, or by a single month of modest price decreases. This Fed will not waver" on getting inflation back to the 2% target.

Markets price

in hikes

While he declined to say what's next for monetary policy, Warsh said, "I want to stress, of course, that decisions by this committee matter a great deal, and where necessary and appropriate, we will not hesitate to act." He noted that bond yields since the Fed's last monetary policy meeting have risen notably - investors have priced in interest rate increases - and he welcomed that move, even while saying it did not mean the central bank needed to ratify it with action. "I was comforted that markets in the inter-meeting period weren't reacting to us" and that traders and investors "weren't reacting to dots or to speeches" from the Fed, but instead relied on their own judgment, Warsh said. The dots refer to the so-called "dot plot" chart of rate projections from Fed policymakers that are released on a quarterly basis. "We don't endorse any particular market move" even as officials observe market pricing "with keen interest," Warsh added.

Since the last Fed meeting in June, the Treasury market yield curve - which plots market-based interest rates at different bond maturities - had flattened, reflecting a sharper move up in the shorter-dated yields closely tied to Fed policy expectations than in those for longer-dated bonds that are more sensitive to the inflation outlook.

On Wednesday, however, that dynamic shifted and the curve steepened sharply as yields on 2-year Treasury notes fell while those for 10-year notes and 30-year bonds moved up. The 30-year bond yield, in fact, crossed above the 5.20% level for the first time since 2007. Some economists said they now saw a path toward higher rates. "At this stage, I think we should expect the FOMC to hike rates by 25 basis points in September unless the labor market data collapses, or core inflation prints closer to 2% annualized, which I do not expect in the July or August readings before the September FOMC," said Omair Sharif, founder and president of forecasting firm Inflation Insights.

The number of officials voting in favor of tighter policy suggests a change in Fed thinking, even though some analysts think the central bank can still hold off on hikes.

"The high number of dissents underscore that policymakers are increasingly more hawkish," Kathy Bostjancic, chief economist at Nationwide, said in a note. But she added that "the Fed can and should remain on hold this year since higher interest rates will not solve the energy supply shock from the Middle East nor slow AI capex that is driving up prices." In leaving the policy rate pinned in the range it has been since December, Fed policymakers are embracing the idea that current borrowing costs are creating enough friction in the economy to reduce any inflation that isn't, like the effect of tariffs on goods prices, expected to fade on its own.

Warsh has said little about the mix of risks and nothing about the outlook for the policy rate, though he has expressed the expectation that rising productivity aided by AI will allow the economy to grow faster without also pushing up inflation.

Financial markets ahead of this week's meeting had priced in about a one-in-three chance of a rate hike and, absent such a move at this week's meeting, nearly a 100% chance of an increase at the Fed's September 15-16 meeting.

After the release of the Fed's policy statement on Wednesday, traders put about a 57% chance on a rate hike in September, according to CME Group's FedWatch tool.

By the time they meet in September, Fed policymakers will have in hand two more monthly readings on inflation and the jobs market, giving them a better picture of whether the cooling price pressures evident last month have continued.