Hot jobs report puts Fed cuts further out of reach as Chair Warsh faces policy tests

Another big jobs report in May has pretty much swept aside the possibility of interest rate cuts anytime soon — and in the process underscored the tricky policy path ahead for new Federal Reserve Chair Kevin Warsh.

The chance of rate reductions already had been on life support heading into Friday’s nonfarm payrolls report.

But the unexpectedly strong gain of 172,000, compounded by sharp upward revisions for prior months, makes the case for policy easing even weaker, particularly considering the elevated level of inflation and uncertainty over the Iran war.

“If I’m at the [Fed], I say, ‘look, job growth is good, there’s no need for us to support the labor market. Inflation is high,'” said Gus Faucher, chief economist at PNC. “So therefore we can keep the fed funds rate where it is right now until we get a better picture of what’s going on on the inflation front.”

Indeed, market expectations shifted even further after the nonfarm payrolls report. Traders priced in an even lower chance of a cut at the June 16-17 meeting and raised the odds of a hike by the end of 2026 to about 70% nearing midday Friday, according to the CME Group’s FedWatch measure of futures prices.

Warsh’s dilemma, though, runs deeper than the simple calculus of where rates are headed. A number of his colleagues have been challenging not merely the chair’s positions but the framework and filter through which policymakers interpret inflation, growth and the appropriate stance of monetary policy.

In recent days, multiple central bank officials have spoken in public and challenged, without mentioning his name, several core policy assumptions and positions that Warsh has held since he emerged as a candidate for the chair’s seat.

There was Governor Christopher Waller expressing worry that consumer and market psychology was in danger of shifting their inflation expectations higher — a key consideration when figuring out how the Fed should react.

St. Louis Fed President Alberto Musalem took on Warsh’s stated belief that artificial intelligence and its anticipated productivity gains would be a disinflationary force on the economy. Instead, Musalem contended, it would be “risky to rely on the prospect of higher productivity growth in the future to solve our inflation problem today.”

Meanwhile, Dallas Fed President Lorie Logan countered Warsh’s reliance on “trimmed mean” measures for inflation. Those gauges toss out the highest and lowest inputs to inflation calculations and focus on readings closer to the midpoint of the data.

Warsh has said that trimmed mean measures indicate that inflation is much closer to the Fed’s 2% goal than the headline data indicates, an important consideration at a time when surging energy prices are having an outsized impact.

“A change in the mix of price increases and decreases is causing the trimmed mean to drop too many price increases. That can pull the trimmed mean below the underlying trend in inflation,” she said in a speech.

What made Logan’s comments particularly notable is that her own Dallas Fed produces the most followed trimmed mean measure, which she effectively cautioned against putting too much weight on. The trimmed mean reading for April put inflation at 2.3%, far below the 3.8% headline and 3.3% ex-food and energy core measure.

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

There were others as well.

Governor Michelle Bowman advocated that the Fed not overreact to what could be a temporary price spike from an energy supply shock. Bowman also stated that she was comfortable with the Fed continuing to use “forward guidance” language in its post-meeting statement that markets have interpreted as a signal that the next rate move could be a cut.

Bowman’s position on the language is both a boon and challenge to Warsh’s positions — he favors lower rates but dislikes forward guidance as an unreliable gauge of future policy.

However, she, too, added a note of caution, saying of the war, “the longer the conflict persists, the more we should consider the effects on inflation in our outlook.”

Finally, Governor Michael Barr recently laid into Warsh’s advocacy for a smaller Fed balance sheet, insisting that such a narrow focus could cause more harm than good.

Warsh also is facing challenges on Wall Street.

The new chair, along with multiple White House officials, have used the mid-1990s Fed under then-Chair Alan Greenspan as a template for a central bank that saw a productivity boom as a disinflationary force to counter a hot economy.

But there are key differences between now and then, according to Jason Thomas, the influential Carlyle Group’s head of global research and strategy. In a recent client note, Thomas argued that real interest rates, or the difference between nominal rates and inflation, were much higher under Greenspan and thus more restrictive then, giving the Fed leeway.

The argument essentially is that Fed policy was tighter in that era than today.

“As Vito Corleone [of The Godfather] asked his assembled guests: ‘How did things ever get so far?’ This is the question Kevin Warsh should pose to colleagues when he chairs his first Federal Open Market Committee meeting later this month,” Thomas wrote.

“Don’t expect any movement this meeting or next; the option value of waiting is too high given the scale of uncertainty introduced by the Strait of Hormuz closure,” he added. “But it’s long past time to abandon the endemic easing bias that’s characterized policy for the past two years.”

Warsh, then, can be expected to meet stiff challenges when the meeting convenes, albeit from a group known for its collegiality.

Cleveland Fed President Beth Hammack, a policymaker concerned about inflation who voted against the April statement because it included the forward guidance language, echoed the concerns over using trimmed mean and core inflation measures, with oil still above $90 a barrel.

What if “I told you that my weight is amazing, I’m looking really great right now. My diet is perfect, except for the donuts I had for breakfast, the fried chicken I’m going to have for dinner, and the ice cream I’ll have after that, but other than that, I am totally on track,” Hammack asked during a recent public appearance. “You have to really 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 that he’s coming in asking some of those big-picture questions. What’s working well? Where can we do better? How do we help support our goals of maximum employment, price stability, and how do we really do that to serve the public?” she said. “I think he is a public servant who will come in with an open mind and try to do his best.”