Even With a New Leader, the Fed Won't Likely Cut Interest Rates Any Time Soon
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Key Takeaways
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Expectations of Federal Reserve rate cuts have fallen significantly since the beginning of the year, even as Kevin Warsh, a Trump nominee, gets set to replace Jerome Powell as Fed chair.
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The Iran war has pushed up gas prices, raising costs and inflation expectations, which lower rates could worsen. Trump’s proposals for further tariffs add to the uncertainty.
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A growing number of Fed officials have become less-inclined to cut rates amid the economic uncertainty, and Powell’s decision to stay on as a Fed governor means Trump won’t be able to nominate a new member of the board who might support cuts.
A rate cut from the Federal Reserve this year, once treated as a near-certainty, is now a long shot.
After the Fed on Wednesday held rates steady at a range of 3.5% to 3.75% for the third straight meeting, financial markets are now pricing in just a 17% chance of a rate cut by year-end, and a 7% chance of a rate hike, according to the CME Group’s FedWatch tool, which forecasts rate shifts based on fed funds futures trading. That’s a stark reversal from early in the year, when the question was when, not if, the Fed would cut next.
The central bank is contending with fast-rising energy prices due to the Iran war and fresh tariffs from President Donald Trump. The prospect of rising inflation stemming from the war and other factors has led a growing number of Fed officials to say that now isn’t the time to consider rate cuts.
The uncertainty about the economic outlook poses a challenge for the incoming head of the Fed, Kevin Warsh, who is due to replace Chair Jerome Powell on May 15 if he receives final approval in the Senate. Warsh was handpicked by Trump, who has repeatedly criticized and insulted Powell for not cutting interest rates more aggressively in recent years.
What This Means For The Economy
The Fed has a dual mandate from Congress: keep inflation low and employment high. It raises rates to cool spending when inflation runs hot and lowers them to encourage hiring when the job market needs help. High rates mean borrowing costs stay high for all kinds of consumer and business loans, which translates into slower economic growth.
The Iran war is a major reason the Fed has held off, Powell said Wednesday at a press conference. The war has effectively closed the Strait of Hormuz for two months, disrupting oil supplies and sending prices for gas and diesel fuel soaring. And although the Fed usually overlooks temporary disruptions, it’s unclear how long the war will last or how much higher transportation costs will push up prices for other goods and services.
Psychology is another factor: if the public believes price hikes will stick, inflation expectations could become self-fulfilling as workers demand higher wages and business increase prices to keep pace with rising costs.
The Trump tariffs have also shifted the inflation outlook. Fed economists tracking how import taxes are passed on to customers have concluded that without the tariffs, inflation would be close to the Fed’s 2% goal. More tariffs are on the way. The government is holding hearings designed to replace the tariffs the Supreme Court struck down.
Inflation has edged higher in recent months. The Personal Consumption Expenditures Price Index, the Fed’s preferred inflation gauge, hit its highest level in almost three years last month, according to a report from the Bureau of Economic Analysis released Thursday. With PCE at 3.5% and rising, progress that would greenlight cuts has stalled.
There’s another obstacle to rate cuts. Powell said he’ll stay on the Fed’s board of governors, denying Trump another seat on the board. That leaves Trump with one open seat, Stephen Miran’s, for Warsh to take once he’s confirmed. As it happens, Miran is the FOMC’s staunchest rate-cut advocate, having voted for deeper cuts than the consensus at every meeting since taking office in September.
A growing faction of Fed officials, meanwhile, is signaling no appetite for cuts. This week’s vote split 8–4, the most dissents at a meeting since 1992. The FOMC’s post-meeting statement contained language signaling the Fed’s next move was likely to be a cut. Three of the dissenters—Cleveland Fed President Beth Hammack, Minneapolis Fed President Neel Kashkari, and Dallas Fed President Lorie Logan—wanted that language out.
In an essay published Friday, Kashkari said that even in a best-case scenario in which the Strait of Hormuz opens soon, he believes interest rates would have to stay where they are “for an extended period and then easing only gradually,” as inflation has been above the Fed’s target for more than five years. And if the Strait is closed for an extended period: “Federal funds rate increases, potentially a series of them, could be warranted, even at the risk of further weakness to the labor market.”
The Fed could still move to cut rates if fears about the job market eclipse inflation worries, according to analysts. But with unemployment claims hitting a five-decade low last week, that seems remote.
“This re-acceleration in inflation, driven by the jump in energy prices, will be enough to keep the Fed on hold for the foreseeable future,” Mike Fratantoni, chief economist at the Mortgage Bankers Association, wrote in a commentary.
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