A Tossup on Rate Cuts Later This Year
Plus: who is Kevin Warsh?
Kevin Warsh, the newly installed Chair of the Federal Reserve, finds himself in an impossible predicament. He must appease the markets, his fellow Fed Governors, and unfortunately for him, the ultimate audience of one, the man who appointed him, President Donald Trump. The goals and needs of each of these distinct forces of nature conflict. Auspiciously but perhaps not surprisingly, Warsh was introduced as the new Fed Chair at the White House and not at the Federal Reserve itself (a break from historical precedent), with Trump saying later that same day that he thinks rates will come down "very quickly.”
But will they? Not if the typical market indicators are to be believed (and acknowledged). First of all, the latest Consumer Price Index report showed inflation running at 3.8%, which is the hottest it’s been since May 2023. It would be economic malfeasance to lower rates when inflation is running hot because, in doing so, lower rates might very well spark further economic fervor, thereby causing inflation to rise even faster (at least according to traditional economic theory).
At the same time, the unemployment rate is 4.3%. This rate has been creeping upward since the recent multi-year lows in the 3.5% range three years ago, but overall, the labor market has been fairly stable (concerns and anxieties around AI and a possible workplace wipeout aside). If anything, the primary stress in the job market is that people don’t feel they are making enough money to keep up, which is largely a reflection of inflation, and not the health of the labor market itself.
A strong jobs report just this past Friday showing 192,000 new jobs created actually sent the stock market spiraling, as the good jobs numbers signaled to investors that rate cuts would be less likely now. It may feel backwards that a strong jobs report ended up leading to a stock market rout on Friday (the S&P 500 fell 2.6%), but it’s because interest rates are such a key variable in the investment world. Anything that suggests rates will stay elevated or even climb is bad news for stock investors, who want the frenzy that might come from lower rates. So it’s good that there were a lot of new jobs created, but bad for the stock market. Like I said, kind of backwards, but that’s how it goes sometimes.
Who is Kevin Warsh?
It’s all fair to ask, then, why would the Fed lower rates now, with inflation too high and employment basically stable. Well, it all depends on whether you think Fed Chair Warsh’s nomination came with strings attached (i.e. “I will appoint you, but you must lower rates.”). Or perhaps Kevin Warsh himself may believe rates need to come down, so it’s less of a puppet scenario and actually just a reflection that Trump appointed him because they share similar philosophies. So, do they?
Kevin Warsh is not an everyday name that many Americans will recognize (other than through recent news coverage), but he is a well-known figure in Federal Reserve circles. Before becoming Chair, Warsh served as a member of the Federal Reserve Board of Governors from 2006 through 2011, putting him in the room during the financial crisis and the Great Recession. Prior to that, he worked in investment banking at Morgan Stanley and later served as a special assistant to President George W. Bush.
Since leaving the Fed, Warsh has spent much of the past fifteen years as one of the institution’s most prominent outside critics. He has repeatedly argued that the Federal Reserve was too slow to recognize the inflation surge that followed the pandemic, and has often emphasized the importance of maintaining price stability. In congressional testimony earlier this year, he stated bluntly that “inflation is the Fed’s choice,” reflecting his belief that the central bank bears primary responsibility for controlling inflation.
That history makes Warsh a, well…interesting…choice for a president who has consistently pushed for lower interest rates. Traditionally, Warsh has been viewed as someone who is more concerned about inflation than about stimulating economic growth through lower rates.
The question investors are trying to answer is whether Warsh the critic will resemble Warsh the chairman. Will he prioritize inflation control above all else, consistent with much of his public commentary over the past decade? Or will he prove more flexible now that he sits in the most powerful monetary policy seat in the world? Time will tell.
How Interest Rates Actually Move
To answer the question of how interest rates fluctuate, it’s important to distinguish between several different types of rates. Treasury notes and bonds, for example, fluctuate all day long because they are bought and sold continuously on the open market. Home mortgage rates, which typically correlate with Treasuries, also move daily (although some banks and mortgage brokers might only update their menu of rate options once or twice a week, if that).
The Federal Reserve, however, directly controls only a short-term benchmark known as the federal funds rate. This is the rate banks charge one another for overnight lending. While consumers generally never borrow at the federal funds rate itself, it influences a wide range of other rates throughout the economy. Closely related is the Prime Rate, which commercial banks use as a benchmark for many business loans, credit cards, and home equity lines of credit. When the Fed changes the federal funds rate, the Prime Rate usually moves almost immediately afterward.
The Federal Open Market Committee (FOMC), the Fed’s monetary policy arm, typically meets eight times per year to determine whether rates should rise, fall, or remain unchanged. While emergency meetings are possible, they are rare. The most notable recent example occurred in March 2020, when the Fed held two emergency meetings in the span of two weeks and slashed rates by 150 basis points as the COVID-19 pandemic threatened to shut down large portions of the global economy.
So can Warsh just move rates on his own? The short answer is no. The FOMC consists of twelve voting members: the seven members of the Federal Reserve Board of Governors, the president of the Federal Reserve Bank of New York (by default), and four rotating presidents from regional Federal Reserve Banks around the country. The Chair leads the discussion and often exerts significant influence, but the Chair does not possess unilateral authority. In the end, policy decisions are determined by a majority vote of the committee based on their own read of the economic indicators and their own economic perspectives and philosophies.
So What’s in Store?
There are a lot of variables moving in seemingly opposite directions. Inflation is elevated; employment is stable. Trump wants rates to come down, but Warsh has signaled, at the very least, that he will strive for independence. Plus, as noted, rate decisions are not entirely his alone to make as he works in concert with a board of Fed Governors.
A quick note on inflation: there are signs that inflation is likely to ease back down, which may help make the case for lowering interest rates. The key variable right now is gas prices, which, fortunately for the consumer, have been actually going down over the past two weeks. According to GasBuddy, the average price of a gallon of regular was $4.51 as recently as May 24th. But now, just two weeks later, the price has fallen to $4.13, which is a pretty notable drop in a relatively short period of time. The key reason for this is the hope of a true ceasefire in Iran and the re-opening of the Strait of Hormuz, which will get oil flowing globally again. Countries around the world have also been tapping their oil stockpiles to help ease price pressures at home while they wait for resolution in the Middle East.
If oil does continue to drop, it should have the effect of helping inflation get back towards the desired 2% level. Not only is the price at the pump a key piece of the overall inflation rate, but oil is baked into so many different products and services that an anticipated drop in prices helps ease prices throughout the wider spectrum.
The Odds
In my earlier draft of this article at the beginning of the week, I had the odds at 50-50 for interest rate cuts later this year via the Fed. This was based on analysis from the CME FedWatch Tool. Regrettably I did not capture a screenshot of the 50-50 odds via CME from earlier in the week, and as of this writing late Saturday evening, the website link is broken, so you’re just going to trust me on this one. The 50-50 odds were a 50% chance of rate cuts and a 50% chance of rates generally staying where they are or increasing modestly.
The story was different by the end of the day on Friday, however. Friday’s strong jobs report moved the odds to 60-40 in favor of interest rate hikes by the end of the year. Prediction markets like Kalshi now have a 77% chance of zero rate cuts this year, and a 47% chance of interest rate hikes. The odds climb to a 65% chance of rate hikes by July 2027. In other words, there is now a low likelihood of rate cuts for the remainder of 2026, and by this time next year, interest rates could actually be higher than they are today.
This is not good news for borrowers and would-be borrowers who are anxious for some rate relief. To be sure, rates have actually come down 100-200 basis points (for all intents and purposes, 1-2%), in the past 18-24 months, so there has already been some help for borrowers compared to the interest rate peaks we saw from 2023-2024. But the conventional wisdom at the beginning of 2026 was that rates would ease down throughout 2026, perhaps by a quarter point two or three separate times. Stubborn inflation that has been amplified by an Iran War oil spike and, more positively, a strong jobs market, has not only backed up the timeline of interest rate cuts, but started to bake in rising rates.
We’ll see what happens over the coming months. I expect gas prices to continue to ease down. Oil is just one variable (albeit it a notable one) in complicated mess of politics, economics, and global affairs leading up to the November midterm elections here in the United States.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Thoughts and opinions here do not represent First National Bank.