Warsh says Fed may hike rates as inflation holds at 3.7%

Fed Chair Kevin Warsh said Aug. 28 that inflation at 3.7 percent remains too high and the central bank may need to raise rates, pushing two-year Treasury yields to 4.316 percent.

"Warsh strengthened his inflation credentials by acknowledging the problem directly, reaffirming an unambiguous 2 percent target and accepting institutional responsibility for the Fed's failures," said Christopher Hodge, chief U.S. economist at Natixis.

The two-year Treasury yield rose 8.5 basis points to 4.316 percent, its highest in a month, while the 10-year yield gained 2 basis points to 4.694 percent. The dollar index climbed 0.4 percent to 99.48. Futures markets now price roughly a coin-flip chance of a hike at the Fed's Sept. 15-16 meeting, up from 35 percent before the speech.

The stakes are high for the new Fed chair, who replaced Jerome Powell on May 22. Warsh has refused to provide forward guidance, arguing it limits the Fed's flexibility. But his Jackson Hole remarks suggest rates at 3.50-3.75 percent may not be restrictive enough to cool price pressures that have persisted for five years.

Warsh, in his first high-profile speech at the Fed's annual Jackson Hole conference, acknowledged that recent inflation reports show some cooling but said they "do not tell me that underlying trends have meaningfully improved." He pointed to data showing that 54 percent of goods and services tracked by the government have seen price increases of 3 percent or higher over the past year — well above the 32 percent that saw such increases in the two decades before the pandemic.

The Fed's preferred inflation gauge, the personal consumption expenditures index, stood at 3.7 percent in July. The fed funds rate has been held at 3.50-3.75 percent since December 2025, after the Fed cut rates through the second half of that year. Warsh said short-term interest rates are the "predominant tool" the Fed can use to lower inflation, and he suggested current levels may not be sufficiently restrictive given strong consumer spending and business investment in AI infrastructure.

"Warsh accomplished what he was trying to do, which is get his point of view across without really disrupting the markets," said Mark Hackett, chief market strategist at Nationwide. "He's telling the market, do not expect cuts any time until we have this thing completely under control, and do prepare yourself for hikes."

The last time a Fed chair used a Jackson Hole speech to telegraph a shift in policy was August 2022, when Powell warned that sharply raising rates would bring "pain" to consumers and businesses as inflation hit 9.1 percent. The S&P 500 fell 19 percent that year as the Fed lifted rates from near zero to 5.25-5.50 percent. This time, the benchmark index has held steady, up 0.3 percent Friday, as investors weigh whether Warsh's hawkish tone will translate into actual policy action.

Rate Path Uncertainty

Longer-term yields have risen steadily in recent weeks on U.S. government deficits and heavy borrowing by tech firms building AI infrastructure. The 30-year Treasury bond reached its highest level in 19 years last week, prompting Treasury Secretary Scott Bessent to buy back bonds to push yields lower. The 30-year yield slipped 0.6 basis points to 5.186 percent Friday.

Warsh also sought to clarify remarks from his July 29 press conference, specifying that short-term interest rates — not the balance sheet — are the primary tool for fighting inflation. He noted that inflation data "are more concerning" than labor market trends, where unemployment remains low.

"Warsh was more hawkish than expected from the marketplace," said Chris Gunster, head of fixed income at Fidelis Capital. "We have lower inflation expectations on the longer term and higher inflation expectations in the really short end."

The political backdrop adds another layer. President Donald Trump has continued to call for lower rates while renewing efforts to remove Fed Governor Lisa Cook, a Biden appointee. Replacing Cook would give Trump a majority of the seven-member board. Warsh, whom Trump appointed, has defended the Fed's independence while declining to comment on the president's pressure.

Wall Street now sees the potential for a hike at the Sept. 15-16 meeting as roughly a coin flip, according to CME FedWatch data, up from one-third before the speech. If inflation data due in the coming weeks show continued strength, economists expect the Fed to move by year-end.

"If we get a stable or stronger labor market report next week and then a stronger inflation print the following, that's going to suggest Warsh is ready to go as well," said Molly Brooks, U.S. rates strategist at TD Securities.

This article is for informational purposes only and does not constitute investment advice.