The Federal Reserve under new chairman Kevin Warsh is about to show whether it intends to operate differently from recent predecessors, and this week's policy meeting will provide the clearest signal yet.
Markets are assigning roughly a one-in-three chance that the Fed raises interest rates when it concludes its two-day meeting Wednesday. That's a sharp jump from just 16% a week ago, driven by Middle East tensions that pushed oil prices and bond yields higher. For decades, the central bank has announced rate moves in advance, conditioning markets for what comes next. A surprise hike would signal a fundamental shift toward greater policy flexibility and less predictability.
Before the Fed entered its blackout period, officials appeared inclined to hold rates steady while signaling that future increases remained possible if inflation didn't cool. The recent geopolitical escalation changed that calculus for traders betting on CME's FedWatch tool. The question now is whether Warsh views that as reason enough to act.
Warsh has spoken frequently about entering policy meetings with an open mind and letting internal debate, which he calls a "family fight," determine the outcome. That rhetoric suggests a willingness to consider a wider range of moves than his immediate predecessors favored. But it also raises an uncomfortable tension: How reactive should the Fed be to news that moves markets day to day?
Bill English, a former top Fed economist now teaching at Yale, frames the dilemma clearly. "Since markets have priced in about a one-third chance at this meeting, there will be some surprise no matter what the FOMC does," he told Axios. The real risk, he argues, isn't surprising markets occasionally. "I don't see a problem with the Committee surprising markets at a particular meeting," English said. "But I do see a problem with not explaining the reasoning behind a move or lack of move because that could lead markets to react unexpectedly."
That puts Warsh on notice for his press conference Wednesday. He'll need to articulate clearly why the Fed acted or held steady, especially if he's departing from the cautious approach that Jerome Powell championed.
Powell had learned an uncomfortable lesson from the "taper tantrum" of May 2013, when then-chairman Ben Bernanke surprised bond markets by suggesting the Fed might slow its stimulus. The shock sent longer-term rates sharply higher during a fragile recovery. Powell later said he wanted interest rate expectations at "way north of 50 percent" before any move, adding "I think it would be very unwise to lift off at a time when the market is not expecting it."
The Fed has indeed surprised markets before, but typically only during crises. The 2008 financial collapse and 2020 pandemic each sparked emergency meetings with outsized rate cuts designed to prevent economic catastrophe. The June 2022 supersized hike signaled resolve against inflation. Even those moves, though, had some telegraphing through press reports beforehand. In September 2008, right after Lehman Brothers collapsed, the Fed opted not to move at all, with officials arguing it was wiser to wait and see how events unfolded.
The European Central Bank just faced a similar situation. President Christine Lagarde decided last week to hold rates steady, arguing that policymakers shouldn't overreact to oil price swings in an unresolved conflict. "We have seen so abrupt changes, occurring in a matter of days, not just in terms of the level of the conflict but also the consequences in terms of energy prices," Lagarde said.
The tension for Warsh is real. A $10 swing in crude oil, much of which has already reversed, may not warrant overturning what officials preferred 10 days ago. Yet markets are braced for action. Whatever Warsh does, he cannot avoid disappointing someone's expectations. The question is whether he can explain his choice convincingly enough to keep markets from reacting unexpectedly to the surprise itself.
Author James Rodriguez: "Warsh is about to learn whether the era of the predictable Fed can actually end, or whether market discipline will pull him right back to Powell's playbook."
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