Kevin Warsh’s Fed press conference will be revealing: Analysis

Federal Reserve Chairman Kevin Warsh isn’t likely to oversee an increase in interest rates at this week’s Fed meeting, for at least three reasons.

First, Warsh personally doesn’t seem to buy the arguments for hikes. Second, raising rates would undermine the outcomes of his task forces. And, third, a rate increase risks putting him on the wrong side of some uncomfortable politics with the Trump administration.

And yet Warsh faces a divided Federal Open Market Committee, with perhaps three or four people out of a dozen voting members prepared to call for immediate rate increases. Investors see a nearly 40% chance of a rate increase this week, according to CME FedWatch. Warsh would face an uphill climb at the committee meeting to merely keep rates steady, so how he addresses each of those three key rationales will be revealing.

First, Warsh arguably doesn’t want higher rates right now, and he hasn’t promised anything. He has committed to ending “forward guidance,” a practice of precommitting the Fed to a particular course on interest rates. That means he won’t say in advance how he plans to vote when the FOMC meets. 

But Warsh has given some clues to his so-called reaction function, or how he and the Fed more broadly interpret and respond to incoming data. Warsh has weighed in specifically on how he processes data on two large forces stressing the economy: energy-price hikes from the Iran war, and rising costs for semiconductors and electricity as companies build out their artificial intelligence capabilities.

Gas and diesel prices have shot up in recent days after the U.S.-Iran ceasefire broke down. Warsh described that in fairly dismissive terms in Senate testimony on July 15: “Particular price shocks happen to particular prices that we don’t have control over.” In other words, there is little the Fed can do in the short run to expand capacity at maxed-out U.S. refineries. 

That might be a problem if the spike in energy prices looked to be raising prices more broadly across the economy, but consumer-price-index data for June released just before Warsh spoke showed broader prices actually falling before the recent return to hostilities. 

Some of Warsh’s colleagues at the Fed have warned about the potential for tech companies to raise prices on semiconductors, electricity and more as they spend heavily to build out their artificial intelligence capabilities. But as with energy, Warsh told the Senate he wasn’t necessarily concerned. He doesn’t “view a one-time change in prices as necessarily being inflationary, because I think there’s a supply response in that way.”

The Fed will have to decide whether this particular shift in supply and demand constitutes the kind of inflation that needs to be…