Kevin Warsh is set to take over as head of the US Federal Reserve later this week, facing pressure from the White House to cut interest rates amid growing determination from his colleagues to maintain the status quo. Now, the bond market is exacerbating this pressure.

The yield on 30-year Treasury bonds reached its highest level since 2007 on Tuesday, amid heavy selling of government bonds, triggered by the recent surge in energy prices resulting from the US-Iran trade war.

Added to this are concerns about the US budget deficit and signs that the economy remains strong, amid investors seeking higher returns to own long-term debt.

Subhadra Rajappa, head of US research at Societe Generale Americas, explained that rising yields may not be an intended test for the next Federal Reserve chair, but it certainly makes his job harder.

She added that Warsh is entering the fray at a time of rising inflation, and his protectionist tendencies are likely to be challenged either by market pricing or by his future colleagues at the Federal Reserve.

Trump's pressure to lower interest rates

Warsh will be sworn in on Friday as the 17th Federal Reserve chairman at a White House ceremony hosted by U.S. President Donald Trump.

Trump said in an interview with the Washington Examiner on Tuesday that he would let Warsh decide what to do with interest rates, but indicated last month that he would be disappointed if Warsh did not cut interest rates immediately upon taking office.

In the months leading up to his nomination, Warsh criticized the Federal Reserve for not cutting interest rates enough, pointing to long-term dynamics in the economy, namely an expected surge in productivity growth linked to artificial intelligence, which might justify the cuts.

But he has not expressed his political views for several weeks. During his confirmation hearing on April 21, lawmakers failed to press him for his near-term views on interest rates.

Inflation fears

Meanwhile, most of the arguments in favor of lowering interest rates have faded. The labor market, which last year showed signs of serious strain, now appears stable. And inflation, which had already stalled before the war, has risen again on the back of energy prices.

Julia Coronado, founder of the research firm Macro Policy Perspectives and a former Federal Reserve economist, said: There really isn't anything that can be pointed out as non-inflationary, and the war adds to the fiscal picture because, well, we're going to need to finance it.

She added that Warsh should be deeply concerned about this reaction. The path to lowering interest rates at this stage leads through an economic recession.

The reluctance of Warsh's future colleagues to consider cutting interest rates anytime soon may offer some comfort to investors. Only one policymaker, outgoing Governor Stephen Miran, continued to advocate for lower rates. Warsh will replace him on the Federal Reserve Board of Governors.

The rest said they were comfortable leaving interest rates unchanged, as they had done at their last three meetings. A growing minority, concerned about the inflation outlook, suggested it was time to change the language of the Fed's post-meeting statement and include a signal that interest rates could be raised, not just lowered, in the next move.

Michael Feroli, chief U.S. economist at JPMorgan Chase, said: “People seem relieved that the committee will be setting policy, rather than the new chair dictating a new direction at the Federal Reserve.” He added: “He’s going to have a much tougher job trying to convince anyone of the case for a rate cut at any point this year.”

The minutes from the Federal Reserve's April meeting are due to be released on Wednesday and may reveal more about how the committee views the path forward.

thorny transition

Recent market movements further complicate an already delicate transition at the Federal Reserve. Even before the war, Warsh faced economic forecasts of steady inflation and a stable, albeit somewhat fragile, labor market. He must also build influence among other policymakers, while the presence of his predecessor, Jerome Powell, on the Fed remains significant.

Outgoing chairman Jerome Powell said he would remain at the Federal Reserve because of concerns that White House attacks on the central bank's independence would continue.

Nate Hyde, a portfolio manager at Insight Investment Management, believes there is certainly a risk that Warsh could find himself in a very uncomfortable situation that he doesn't really have the ability to resolve.

He added: If you don't have a board of directors, and you're under pressure from the president, you don't really have many options other than to smile and endure while you try to build consensus.

However, at least one team of Federal Reserve watchers recommended a possible escape route for Warsh: taking an anti-inflation stance by removing phrases from the post-meeting policy statement that suggested officials would eventually resume cutting rates.

According to analysts at Yardeni Research, eliminating the so-called easing bias could halt the rise in bond yields. In a recent note to clients, they wrote: By acting hawkishly, Warsh may have an opportunity to deliver what the White House wants: lower real-world borrowing costs.