Preliminary data released since Kevin Warsh took over as chairman of the Federal Reserve indicates that inflation is declining, which makes his job somewhat easier.
So far, there are insufficient justifications for lowering interest rates, given the strength of the labor market and the fact that annual inflation remains well above the Federal Reserve's 2% target. However, the arguments for raising interest rates appear less compelling at present.
This situation works in the new president's favor; if investors deem the current interest rate range of 3.5% to 3.75% appropriate, he won't have to offer lengthy explanations. During his testimony before Congress last week, Warsh wisely avoided declaring victory, explaining that the Federal Reserve shouldn't draw broad conclusions from a single month's data. Unfortunately, his task is likely to become even more complicated going forward.
Consumer prices fell in June for the first time in six years, primarily driven by lower energy costs. Inflation for the year ending in June was 3.5%, down from 4.2% in the year ending in May. However, fluctuations in oil prices will continue to affect the overall inflation rate, so progress could stall again if the conflict with Iran escalates further.
In contrast, core consumer price inflation, which excludes energy and food, remained at a less worrying level of 2.6%.
Lower inflation supports Warsh's position
Other measures of core inflation also showed improvement. The personal consumption expenditures (PCE) price index is the Federal Reserve's preferred gauge, and the June reading, due on July 30, can be estimated based on the components already available. The headline index is expected to decline to 3.7% for the year ending in June, compared to 4.1% for the year ending in May, while core PCE inflation, which excludes energy and food, is expected to fall to 3.3% from 3.4%.
With the pace of improvement accelerating in recent months, these rates are expected to continue their year-on-year decline. The effects of tariffs also appear to have already been reflected in prices, while service prices remain virtually stable for the time being.
In other words, the current interest rate appears to be achieving its purpose, gradually curbing demand and slowly lowering inflation. While raising interest rates might accelerate the decline in inflation, it also carries the risk of disrupting the labor market and increasing unemployment.
The inflation data prompted investors to reduce their bets on the Federal Reserve raising interest rates later in the year, and gave Warsh some breathing room, temporarily setting aside doubts about his willingness to raise rates if necessary.
At the same time, Warsh was adamant in reaffirming his commitment to price stability and maintaining the central bank's independence, saying: They chose an independent person to perform an independent task, and that is exactly what I intend to do.
Growing challenges facing Warsh
This honeymoon period is unlikely to last long; the president may soon run out of patience with the Federal Reserve chairman's refusal to cut interest rates amid persistently high inflation.
Warsh began an ambitious reformulation of the Federal Reserve’s role in managing monetary policy, in a shift he describes as a “system change,” but the consequences of this approach remain unclear.
At the same time, the economy faces potentially widespread shocks, most notably the expansion of artificial intelligence and the resulting shifts in productivity. Warsh's desire to reduce transparency regarding the central bank's policy direction has also drawn criticism from investors, who closely follow this information.
Despite everything, Warsh made a good start. Hope remains that his good fortune will continue.
