Viewpoints

Warsh and the bond market vigilantes

The recent bond market sell off is a reminder of the many risks to the market, including Warsh’s appointment as Fed chair. The market is justifiably worried about three of Warsh’s main policy views: (1) productivity growth will solve the inflation problem without help from the Fed, (2) the Fed should be selling off most of its bond holdings and (3) the Fed should be focused on the weakest of the core inflation metrics—the “trimmed mean” PCE deflator.

Independent, but in agreement

President Trump has made it abundantly clear that he wants lower interest rates. Indeed, he has said he will not appoint a Fed chair who does not believe major cuts in the funds rate are warranted and he expects the Fed to cut under Chair Warsh.

Last month, Bessent offered a more flexible message to the Fed. He noted the uncertainty around the Iran war, saying “if they [the Fed] want to wait for some clarity, I understand that.” Indeed, “we should wait for the new chairman, Warsh, and let him lead the next cycle.” Looking ahead, he said, “the conflict will end, prices will come down, and then headline inflation will come down.” This suggests a short honeymoon period for Warsh, followed by a string of rate cuts.

In his campaign for the Fed chair, Warsh has been adamant that he has independently arrived at a similar conclusion. He does not want to lower rates because the President wants it, but because economic fundamentals warrant lower rates. Specifically, he strongly supports two arguments. First, the Fed does not need to hike rates to bring inflation down. Quite the opposite, surging productivity will not only solve the inflation problem, but demands that the Fed cut rates to accommodate .

Second, he argues that any upward pressure on inflation is transitory. Indeed, in his testimony, he argued that the Fed should shift to the “trimmed mean” PCE as its preferred measure of core inflation. This metric strips out the components with both the highest and the lowest inflation. In March, the year-over year increase was just 2.4%, and much lower than other metrics (chart).

President Trump has asked Congress to suspend federal fuels taxes temporarily in order to lower prices paid by drivers at the pump. Unfortunately, doing so probably won't produce the desired result, but energy companies certainly won't object. Here’s why.

A complete version of this commentary is available here.

Grinnin’ Kevin Hassett, a White House economic adviser, said on Fox Business on May 6, 2026: “Credit card spending is through the roof. They’re [households] spending more on gasoline, but they’re spending more on everything else, too.” Hassett went on to say that the spending surge was due to households having “so much more money in their pockets”. Well, if households are running up their credit card balances, yes, they temporarily have “more money in their pockets”. Although Hassett thinks that this is a good thing, I see it as a reason why the increase in energy prices will seep into the prices of non-energy goods and services.

Let’s look at some data that are consistent with Hassett’s credit-card spending hypothesis. Plotted in the chart below are the observations of the eight-week annualized percent changes in commercial bank credit card and other revolving loans. In the eight weeks ended April 29, these loans grew at an annualized pace of 12.7%. So, this is consistent with Hassett’s happy hypothesis about households running up their credit card balances.

Movements in the Federal Reserve Bank of Philadelphia’s state coincident indexes in March were generally muted. In the one-month changes, West Virginia led with a 1.12 percent gain, with North Dakota the only other state with an increase above .5 percent. Five states were down, but Hawaii’s .62 percent drop was the only one larger than .10 percent. Over the three months ending in March, while nine states were down, Hawaii was again the only one with a drop of as much as .5 percent. North Dakota, Indiana, and New Jersey were the only states seeing gains of 1 percent or more. Over the last twelve months, four states were down—West Virginia, which has clearly been quite volatile recently, was off 3.42 percent, but no other fell as much as half that. No state had an increase higher than four percent, and only three were higher than three percent.

The independently estimated national estimates of growth over the last three and twelve months were, respectively, .50 and 1.76 percent. Both measures appear to be fairly consistent with the state numbers.

India’s economic performance in 2025 exceeded expectations across the board. During our recent visit to Mumbai, nearly all contacts expressed surprise at the economy’s resilience. Despite the disruption from Trump’s tariff measures—under which Indian exports faced duties of up to 50% until an interim agreement was reached in February 2026—India still expanded by 7.6% in 2025, an improvement on 7.1% in 2024.

Growth did soften marginally in the final quarter, easing to 7.8% YoY from 8.3% YoY, largely due to weaker net exports. However, the more important takeaway for a domestically driven economy is that private demand strengthened (Figure 1). Consumption-led growth remained robust, and while export growth slowed, import volumes—a leading indicator of domestic demand—picked up significantly.

The Congressional Budget Office (CBO) projects large federal budget deficits, in absolute as well as relative terms, as far as the eye can see. This, by definition, means continued increases in the federal debt, again in both absolute and relative terms. The CBO forecasts that the levels of interest rates across the maturity spectrum over the next 10 years will be approximately where they are currently. My “forecast” is that the levels of interest rates, especially in the longer maturities will be higher than the CBO’s forecast. Be that as it may, the CBO projects that net interest on the federal debt will rise inexorably over the next 10 years. Given that Social Security, Medicare, Medicaid and defense expenditures are projected to dominate federal outlays excluding interest on the debt, there is little room for the federal government to slow the growth in federal spending without precipitating a walker-aided march on Washington, DC. By the way, it is projected by the Social Security Administration that its “trust” fund for old-age benefits will be exhausted by 2036. This means that all else the same, benefit payments to then current recipients will have to be cut. Do you really think “all else will be the same”? I think there will be a change in the law allowing the Treasury to borrow more to allow Social Security to maintain its “promised” benefits. Increasing taxes in a meaningful way appears to be politically unfeasible. Under these circumstances, I believe that the federal government, with “cooperation” from the Federal Reserve will attempt to inflate away its federal debt/debt-servicing challenges. It will do this by the Treasury purposely shortening the maturity structure of the federal debt and inducing the Federal Reserve, which dominates the level of short-maturity interest rates, to maintain the federal funds rate at a below-equilibrium level. This will result in a steepening in the yield curve, with the level of longer-maturity interest rates increasing relative to the federal funds rate as well in absolute terms. This will be accompanied by faster growth in the credit created by the Federal Reserve and the depository institution system, i.e., credit created, figuratively, out of thin-air (drink). In turn, this faster growth in “thin-air” credit will result in higher inflation.

Plotted in Chart 1 are fiscal-year observations of federal budget deficits (-)/surpluses (+) in absolute terms (blue line) and relative to nominal GDP (red bars). Historical data run from FY 1965 through FY 2025 and CBO projections are from FY 2026 through FY 2036. By FY 2036, the CBO projects that the federal budget deficit will be $3.1 trillion, compared with $1.8 trillion in FY 2025. As a percent of GDP, CBO projects the budget deficit in FY 2036 to be -6.7% compared with a median of -3.0% for fiscal years 1965 through 2025.

State labor markets were, yet again, generally little-changed in March. Three (Texas, Florida, and Tennessee) had statistically significant increases in payrolls. The sum of the changes across the states was 201,700; not very different than the (currently reported) national change of 178,000.

No state reported a statistically significant change in its unemployment rate. 26 states (including DC) had rates significantly different than the national 4.3%, although three of the four largest states (Florida, Texas, and New York) had rates not significantly different (indeed, the rate in Texas was 4.3%). Rates at or above 5.0% were in DC, Delaware, Nevada, California, Oregon, Illinois, Washington, and Michigan, with DC’s 6.3% the highest. Alabama, Hawaii, North Dakota, South Dakota, and Vermont had unemployment rates under 3.0%, while South Dakota’s 2.3% was the lowest in the nation.

Puerto Rico’s unemployment rate was unchanged at 5.6% and the island’s job count rose 1,800.

The surge in inflation in March is likely to be repeated in April and will continue as long as the Straits of Hormuz remains closed and energy inventories get tighter and tighter. The FOMC and its prospective new Chair have some work to do if they want to restore the Fed’s anti-inflation credibility.

The Cleveland Fed publishes a “nowcast” for the next CPI and PCE inflation releases. For the core they simply extrapolate the recent trend. However, for food and energy they look at actual daily data and hence they get a good estimate of what headline inflation will look like.

https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting

Recall that the consumer price survey is taken over the course of the month. Hence it reflects average prices rather than end-of-month prices. This is important today because food and energy prices rose over the month of March. Hence as the chart below illustrates, the CPI for gasoline will be higher in April than in March.