Hot jobs report puts Fed tapering on the back burner as Chairman Warsh faces policy review

Another major jobs report in May largely swept away the chances of an interest rate cut anytime soon — and in the process underscored the tricky policy path ahead of new Federal Reserve Chairman Kevin Warsh.

The possibility of a rate cut has long been supportive of human health as it enters Friday’s non-farm payrolls report.

But the unexpected strong gain of 172,000, combined with the sharp upward revision of previous months, makes the policy case even weaker, especially given the high rate of inflation and the uncertainty about the Iran war.

“If I am there [Fed]I say, ‘look, job growth is good, we don’t need to support the labor market. Inflation is high,'” said Gus Faucher, chief economist at PNC. So we can keep the fed funds rate where it is until we get a better picture of what’s going on in terms of inflation.

Indeed, market expectations changed further after the nonfarm payrolls report. Traders priced in the lowest chance of a rate cut at the June 16-17 meeting and raised the odds of a hike by the end of 2026 to nearly 70% by midday Friday, according to CME Group’s FedWatch futures index.

Warsh’s problem, however, goes deeper than a simple calculation of where prices are headed. A number of his colleagues were not only challenging the chairman’s positions but the framework and filter through which policy makers interpret inflation, growth and the appropriateness of monetary policy.

In recent days, several central bank officials have spoken publicly and challenged, without naming him, many of Warsh’s core policy ideas and positions since he stepped down as chairman.

There was Governor Christopher Waller expressing concern that consumer and market psychology is at risk of turning their inflation expectations higher – an important consideration when determining how the Fed should act.

The President of St. Louis Fed Alberto Musalem echoed Warsh’s belief that artificial intelligence and its expected productivity gains would be a slowing economy. Instead, Musalem argued, “it would be dangerous to rely on the prospect of higher productivity growth in the future to solve our inflation problem today.”

Meanwhile, Dallas Fed President Lorie Logan disputes Warsh’s reliance on “cut” inflation rates. Those gauges throw the highest and lowest inputs into the inflation calculation and focus readings near the center of the data.

Warsh said the cut measures show that inflation is closer to the Fed’s 2% target than the headline data indicates, an important consideration at a time when rising energy prices are having a big impact.

“The change in the combination of price increases and decreases causes the fixed price to decrease significantly. That can reduce the price reduction to below the inflationary trend,” he said in his speech.

What makes Logan’s comments particularly noteworthy is that his own Dallas Fed produces a widely followed benchmark, which he effectively warns against putting too much weight on. April’s cut estimate put inflation at 2.3%, well below the 3.8% headline and 3.3% average for old food and energy.

“I am very concerned that higher interest rates may be needed later this year to fully restore price stability and properly balance both sides of the Fed’s dual mandate,” Logan said.

There were others.

Governor Michelle Bowman has urged the Fed not to overreact to what could be a short-term rate hike due to a supply shock. Bowman also indicated that he was comfortable with the Fed continuing to use “forward-looking” language in its post-meeting statement that markets interpreted as a sign that the next move could be easing.

Bowman’s position on language is both an advantage and a challenge to Warsh’s positions – he likes low prices but doesn’t like being forwarded as an unreliable gauge of future policy.

However, he, too, added a note of caution, saying about the war, “when the conflict continues for a long time, we must consider more the effects of inflation in our vision.”

Finally, Governor Michael Barr recently included Warsh in addressing the Fed’s smaller balance sheet, stressing that such a narrow focus could do more harm than good.

Warsh also faces challenges on Wall Street.

The new chairman, along with many White House officials, used the Fed in the mid-1990s under then-Chairman Alan Greenspan as a template for a central bank that saw rising output as a lever to combat a sweltering economy.

But there is a big difference between now and then, according to Jason Thomas, the Carlyle Group’s influential head of global research and strategy. In a recent client letter, Thomas argued that real interest rates, or the difference between normal rates and inflation, are too high under Greenspan and thus too restrictive at that time, giving the Fed leeway.

The argument is actually that Fed policy was tighter then than it is today.

“Like Vito Corleone [of The Godfather] he asked his gathered guests: ‘How is it that things have come so far?’ This is the question Kevin Warsh should be asking his colleagues when he chairs his first meeting of the Federal Open Market Committee later this month,” Thomas wrote.

“Do not expect a move in this meeting or the next one; the value of the option to wait is too high given the level of uncertainty introduced by the closure of the Strait of Hormuz,” he added. “But it is past time to stop the bias that has been the dominant policy for the past two years.”

Warsh, then, can be expected to face tough challenges when the meeting is called, even though he comes from a group that is known collectively.

Cleveland Fed President Beth Hammack, an inflation-minded policymaker who voted against the April statement because it included forward-looking guidance language, emphasized concerns about the use of cutbacks and inflationary measures, with oil still above $90 a barrel.

What if “I told you my weight is amazing, I look great right now. My diet is perfect, except for the donuts I had for breakfast, the fried chicken I’ll have for dinner, and the ice cream I’ll have afterwards, but other than that, I’m completely on track,” asked Hammack during a recent public appearance. “You really have to think about everything.”

Hammack spoke of having “a conversation” with Warsh “a few weeks ago” and expressed confidence that he is “approaching the job with a real open mind.”

“I think he’s going to come in and ask some of those big-picture questions. What’s working well? Where can we do better? How do we help support our goals of high employment, price stability, and how do we do that to serve the public?” he said. “I think he’s a public servant who will go in with an open mind and try to do the best he can.”