Warsh's credibility is on the line this week as Trump policies put pressure on Fed to hike

Before President Donald Trump reels off angry Truth Social posts if the Federal Reserve hikes rates this week, he should look in the mirror: His policies are a big reason the central bank has to consider a rate increase.

In March, one month after the beginning of the Iran war, with oil near $100 a barrel, the average Fed official was still forecasting a rate cut this year and another one next year.

It was a sign of the Fed's continued willingness to "look through" policies of the Trump administration that resulted in higher prices and to treat them as "one-offs."

Six months later, the Fed stands on the verge of what markets expect to be the first rate hike since 2023. And futures markets predict this is will not be a one-off increase. At least three hikes are priced in through March of next year.

It's a stark turnaround, but not one based on bad forecasting.

No president has publicly harangued and harassed the Fed more to lower interest rates. So it's ironic that a direct line can be drawn from Trump's policies to what looks like an inevitable rate increase Wednesday by the Fed, likely to be spearheaded by his handpicked Fed chairman, Kevin Warsh.

Two aspects of the president's policies look to be forcing the hand of the Fed.  First, the policies themselves. Tariffs and the Iran war have both resulted in sharp changes to the inflation outlook. But, second, and potentially more consequential, may be the inability to judge the trajectory of policy. The Iran war, six months on, looks to have no end in sight. The situation has clearly worsened with the temporary shutdown of the Saudi East-West pipeline. Fed officials need to consider that oil prices won't be falling quickly.

The president himself no longer responds to crude price increases with a proclamation of an imminent deal with Iran. The surge in diesel prices to $6 a gallon threatens to push inflation deeper into the economy, such as food and transportation costs. The president said on Monday that diesel prices have risen more because of the war in Ukraine than the war in Iran.

WTI crude oil futures, YTD

The same is true for tariffs. Just last week, the president levied new tariffs on Canada in response to its retaliatory tariffs in response to U.S. tariffs. While small by themselves and unlikely to spark broader inflation, they will add to existing price pressures from the levies. The president has threatened even more tariffs on the second-largest U.S. trading partner. The message to the Fed once again is there is no guarantee of anything, especially tariffs, being one-off in the Trump presidency.

In his Jackson Hole, Wyoming, speech, Warsh said if the Fed wasn't confident that underlying inflation was declining, it would have "work to do." Warsh could gain that confidence with an apparent path to an end to the Iran war or some assurance that the president is satisfied with the current tariff regime.

The recent dissent by Minneapolis Fed President Neel Kashkari, though it didn't mention the president or his policies, shows the growing concern with cumulative inflationary policies. Kashkari said he initially believed that the Fed could "look through" a one-time rise in prices from a supply shock.

Now, he wrote, "I increasingly believe that monetary policy does have an important role to play in addressing a series of successive supply shocks that might lead to entrenched higher inflation." Kashkari noted that this was the response of the Fed to successive shocks in the 1970s. "Policymakers ultimately concluded that tight monetary policy was necessary to bring inflation back down despite their original supply shock diagnosis."

The president has forced Warsh's hand to hike in another, more subtle way. By calling so publicly for rate cuts and picking a Fed chairman whom he suggested was on board, the president undermined his own chair's credibility from day one. The proof of this came from Warsh's first congressional testimony where he said a sign of his independence came in his failure so far to cut rates as the president had desired.

Warsh would be unlikely to hike solely because of the credibility issue. But it could play a factor if it's a close call, where the new chairman and the Fed would have more to lose by not hiking. Numerous Fed observers have noted that the chairman's reputation faces a test this week after his hawkish speech in Jackson Hole.

"Everything is pointing in the direction of September as a time to move if Warsh and his colleagues are going to maintain credibility,'' former Vice Chair Roger Ferguson said on CNBC.

Now, with inflation above target and no visibility on lower oil prices or stability of tariffs, the Fed chairman needs to pass the test that has faced his predecessors: proving to markets he's willing to risk a downturn and defy the administration to combat inflation, no matter what party is in power.

It is never the Federal Reserve's place to judge administration policy as good or bad. Its only job is to assess their impact on the economy. On that basis, given recent developments in Iran and the Trump administration's actions regarding tariffs, it would seem difficult for the Fed to assess them as anything but leading to higher inflation in the months ahead.