In the end, Kevin Warsh’s Federal Reserve acquitted itself well. For all the uncertainty he had sparked at the previous meeting of the Federal Open Market Committee, when he refused to provide any indication of what he was prepared to do to tame stubborn inflation, the chair on Wednesday presided over a unanimous decision to raise interest rates for the first time in three years. Welcome though it was, his embrace of economic orthodoxy nonetheless did little to dispel the Keystone Cops quality of governance in Donald Trump’s US.
Warsh’s resolve – raising rates just a few weeks before elections that will determine whether Republicans retain control of Congress – appeared even more resolute in the face of a veiled threat from White House economic adviser Kevin Hassett, who pointed out to his chums on Fox that “if you want an independent Fed, then one thing the Fed does is it stays out of the way of elections”. The central bankers’ parsimonious comments in the press conference following the meeting made a sharp contrast with the more unhinged commentary from other members of the administration, including the president himself, who earlier this month celebrated the resilience of the labor market with a mind-boggling threat to “STOP TRADING WITH COUNTRIES WITH WHICH WE HAVE A DEFICIT” unless the Fed cut interest rates. Trump has yet to turn on Warsh in the way he did on his predecessor, Jerome “numbskull” Powell.
But the signs are ominous. After the rate hike, Trump went ballistic – spewing more of the random, incoherent thoughts that have become his trademark. He again demanded the powers that be to “LOWER THE INTEREST RATES FOR THE UNITED STATES OF AMERICA, AND FAST!” Yet more significant than the contrast between Warsh’s words and the incongruent economic rhetoric from the White House is the tension between the Fed’s decision on Wednesday and pretty much every other initiative from the administration, from the volley of tariffs against imports from everywhere to the war in Iran to Trump’s “promise” of $5,000 a head if he wins the midterms to treasury secretary Scott Bessent’s desperate efforts to pull interest rates down even as the Fed is raising them.
All things considered, financial markets reacted relatively calmly to the day’s events. For sure, the S&P 500 index took a nosedive on Wednesday afternoon, closing some 0.4% lower at the thought that the Fed would likely now raise rates again in December and twice in 2027. The yield on the 10-year bond rose sharply, again surpassing 5%.
But investors appear to have bought – for now at least – that whatever deranged policies may emerge from the rest of the administration, monetary policy will remain comparatively sane. Investors should probably remain on their toes, though. A rational Trump would probably thank Warsh for his hawkishness.
There might be a plausible argument to keep rates where they were because inflation is driven by temporary forces, like a war. Yet had the Fed staid its hand, or – goodness forbid – cut rates as the president has demanded, the bloodbath in the treasury market would have been gruesome, as investors were forced to accept that the chair of the central bank would not stand up to the nut who appointed him. By contrast, by raising rates and demonstrating he is serious about curbing inflation, the Fed is likely to calm market jitters and reduce long-term inflation expectations, which will ultimately redound in lower yields on treasury bonds, allowing for lower interest rates on mortgages and other long-term loans that matter to businesses and consumers.
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