US-Iran agreement takes the heat off Kevin Warsh

By Matt Egan, CNN

New York (CNN) — Kevin Warsh’s dream of becoming Federal Reserve chairman was nearly tarnished by the specter of having to confront simultaneous and conflicting challenges brewing in the US economy.

In January, when President Donald Trump nominated Warsh for the top job, the labor market had just wrapped up one of its weakest years in decades. Unemployment was rising and the US economy was losing jobs.

And then, weeks later, the inflation side of the Fed’s mandate reared its ugly head. The war with Iran caused oil, diesel, jet fuel and gasoline prices to skyrocket.

That raised the risk of Warsh having to lead the Fed through a dreaded two-sided battle, with officials forced to decide whether to rescue the job market by cutting rates or put out the inflation fire by hiking rates.

But now, the immediate challenge facing Warsh looks a bit less daunting.

Not only has the job market raced back to life this spring, but energy prices are plunging. The US-Iran agreement to halt the 15-week-long war and reopen the Strait of Hormuz has eased fears of a lasting inflation spike, reducing the urgency for Warsh to consider a rate hike in the immediate future.

“It takes some pressure off Warsh. It means the worst-case for hikes is more off the table than on it,” said Benson Durham, a former Fed official and founder of DASM LLC, an independent research firm.

‘Smaller inflation wave than feared’

To be clear, Warsh was never going to raise rates in his first meeting this week. The odds of a rate hike on Wednesday are almost zero. He was likely not going to cut rates either, even though he faces intense pressure from Trump, who has joked that he would “sue” Warsh if he doesn’t lower borrowing costs.

But a growing number of Fed officials have warned that rate hikes could eventually be needed to drive inflation down.

Even though details remain scarce on the US-Iran framework and many challenges remain, oil futures plunged to three-month lows on Monday.

Gas prices, which play a key role in shaping consumer psychology about inflation, have already declined 25 days in a row to two-month lows.

“The lower path for oil means a smaller inflation wave than feared… less extended supply chain disruptions and, importantly, much reduced risk of a spike to new highs that would shock inflation expectations,” Krishna Guha, vice chairman and head of economics and central bank strategy at Evercore ISI, wrote in a note to clients on Monday.

The US-Iran framework and oil market sell-off is “nudging up the likelihood that the Fed will be able to tough it out without raising rates,” Guha said.

Eric Rosengren, former president of the Federal Reserve Bank of Boston, told CNN that the US-Iran framework is “clearly positive news.”

“It’s a first step but it’s a positive for the economy and the Fed,” he said.

However, Rosengren noted that the formal signing of the agreement is not scheduled until Friday, after the Fed meets.

“I don’t think they will put too much stock in a memorandum of understanding that doesn’t have details sorted out. It only takes a bomb in Beirut or a ship getting attacked to completely change the environment,” he said.

Less pressure to hike

Indeed, oil market researchers caution that the US-Iran agreement won’t immediately return traffic in the Strait of Hormuz to pre-war levels.

And the market is not signaling a swift return to pre-war prices either. The futures market doesn’t see Brent returning to $75 a barrel until 2028.

Still, Fed watchers say the fact that there is a US-Iran framework will allow Fed officials to avoid overreacting to another hot inflation report in June. The agreement boosts the wait-and-see approach advocated by doves at the Fed, who are generally more willing to keep rates lower.

“The Fed is on a firmer footing and has a little more certainty about next steps. The Fed is now less likely to react strongly to near-term inflationary pressures,” said Durham, the former Fed official who now teaches at Columbia University and New York University.

Of course, Warsh still faces plenty of challenges, including winning over the new colleagues he was previously critical of.

“Kevin is very good one-on-one. He’s a smart guy and very personable,” said Rosengren, who served with Warsh at the Fed during the 2008 financial crisis.

Inflation hawk or dove?

Back then, Warsh sounded deeply concerned about inflation.

Even in April 2009, during the middle of the Great Recession when unemployment was skyrocketing, Warsh said he was “more worried about upside risks to inflation than downside risks,” according to Fed meeting minutes that were later released. (At the time, the Consumer Price Index was -0.4%, compared with 4.2% this past May).

More recently, as Warsh was being considered as a replacement for Jerome Powell, he expressed a willingness to cut interest rates in part because of hopes that the artificial intelligence boom will raise productivity and lower inflation.

“During the financial crisis, he was very concerned about inflation, including energy prices,” Rosengren said. “I hope now that he’s not running for the job, he goes back to being as concerned about inflation as in the past.”

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