Trump set to explode if his man does his job

“Fed Week” has started with a bang, with the world’s benchmark interest rate breaking through a key threshold and oil prices surging solidly above $US100 ($140) a barrel again.

When the members of the Federal Reserve Board’s Open Market Committee, which begins its two-day meeting on Monday afternoon (Washington time), sit down to decide whether to lift their policy rate, they’ll also have to factor in the hotter-than-expected inflation data from late last week.

Financial markets have no doubt what they’ll decide: they’ve priced in a 25-basis point hike at this meeting and at least two more, and perhaps three, similar moves between now and June next year. The probability of a rate rise at this meeting is priced at about 90 per cent.

If the Fed does as the markets expect and raises the federal funds rate for the first time since July 2023, when the central bank was still dealing with the inflation shock generated by the post-pandemic disruptions to global supply chains, it will be on a collision course with the Trump White House.

At the weekend, Donald Trump again said the US should have the lowest interest rates in the world and again threatened to cut off trade with countries which have a trade surplus with the US if the Fed didn’t lower US rates. (Even though ending trade with most of America’s trading partners would help lower their interest rates, and would be more likely to lift the US inflation rate and interest rates than lower them).

Kevin Warsh, handpicked by Trump as chair of the Fed, is in an awkward position, partly of Trump’s making, but compounded by his own decisions.

Trump’s trade wars and his war in the Middle East have bled into the inflation rate and the cost of living for American households.

Last week’s inflation numbers showed a rise in headline inflation of 40 basis points between July and August, to 3.4 per cent. The inflation rate has now been above the Fed’s 2 per cent target for 5½ years.

The war in the Middle East has raged for nearly seven months, with no end in sight. Oil prices have rocketed from about $US60 a barrel before the US and Israel attacked Iran in February to about $US106 a barrel this week, having been above $US107 a barrel on Monday.

US gasoline prices have risen about 45 per cent and diesel prices 60 per cent as a result of the war, with the average price of diesel – the key transport fuel – moving above $US6 a gallon for the first time last Friday. It’s now at $US6.23, compared with $US3.76 a gallon just ahead of the onset of the war.

The longer the war drags on – the longer diesel and gasoline prices remain elevated – the greater the likelihood that the fuel costs that businesses appear to have largely absorbed to date will bleed into the wider economy and more materially into the inflation rate.

The impact of Trump’s trade war seemed to have passed through the economy and the data earlier this year, having a one-off effect on goods inflation, but then Trump announced a new suite of global tariffs – and a punitive new tariff regime for Canada – that will prolong the tariffs’ impacts on prices.

Warsh hasn’t helped himself. Having decided that he doesn’t like the Fed providing guidance to the markets because wants the markets to provide signals to the Fed rather than respond to the Fed’s view of the outlook for the economy, he’s now getting what he asked for.

The yield on the US 10-year bond – the world’s most important and influential interest rate – topped 5 per cent on Monday. It momentarily hit 5 per cent in 2023, in response to the burst of inflation generated by malfunctioning global supply chains, but hasn’t held above 5 per cent since 2007, before the global financial crisis.

The market is saying that the US has an inflation problem, and perhaps even a growing credit risk problem. If Warsh ignores the market’s message, the likelihood is that yields will rise even more.

That rise in the 10-year bond yield has come despite (or perhaps because of) US Treasury Secretary Scott Bessent’s arrogant and clumsy attempt to manipulate the market and lower the government’s interest costs by launching a buy-back of longer dates bonds this month. Bessent took on a $US32 trillion market, dared it to take on the US government and, not surprisingly, lost.

Bond investors have become increasingly focused on the government’s debts of more than $US40 trillion and a budget deficit that was $US1.97 trillion in the first 11 months of the US financial year (which runs from October 1 to September 30). The annual interest cost on that debt is running at about $US1.25 trillion and is rising every time a bond issued in a lower interest rate environment matures and has to be refinanced.

Warsh also created reference points for himself at the Jackson Hole conference of central banks and economists last month, when, to make up for a poorly received press conference after he chaired his first Open Market Committee meeting, he presented himself as a firm inflation hawk.

With the midterm elections now less than two months away, the Republicans are under pressure and Trump is becoming more desperate because he knows the personal consequences of the Democrats seizing control of Congress.

“There should be no misunderstanding,” Warsh said at the time.

“The Fed’s price-stability objective of 2 per cent … is a firm, fixed target. Price stability is not self-executing, nor is inflation necessarily mean-reverting. It’s the Fed’s job to deliver stable prices.

“Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job, our mandate and our charge to keep.”

It is indubitable that the inflation rate is, and has been for years, well above the Fed’s target so, if Warsh is to be true to the commitment gave at Jackson Hole, he has to raise the policy rate.

If Warsh doesn’t, the rest of the committee – much as they might dislike the idea of defying their chair – might well do it anyway. Recent Fed meetings have shown a rise in the number of officials arguing for an increase in the rate.

A failure to meet the market’s expectations and the expectations he himself also raised would undermine Warsh’s credibility and perceptions of his and the Fed’s independence from the Trump White House. It would also raise the prospect of investors adding a political risk premium to the yields.

With the midterm elections now less than two months away, the Republicans are under pressure and Trump is becoming more desperate because he knows the personal consequences of the Democrats seizing control of Congress.

There’d be lots of inquiries into the extraordinary wealth he and his family have added since Trump regained the White House, and potential impeachments.

The level of desperation was underscored by Trump’s pledge of $US5000 cheques to every American if the Republicans retain control of both chambers of Congress, funding it with “trillions” of tariff revenues that don’t exist and adding to the deficits, debt and inflation.

Warsh knows he risks Trump’s ire if the Fed raises the rate and that he will be even less popular with the White House in future because 25 basis points won’t by itself tame inflation. Once started on a rate-hiking cycle, the Fed will have no alternative but to continue until the inflation rate is clearly on track towards the 2 per cent target.

So far, Trump has said nothing but nice things about Warsh, blaming other “very political” Fed members for Warsh’s failure to deliver the lower rates Trump keeps demanding.

His opinion might change, dramatically and aggressively, if Warsh delivers and defends a rate rise – or even two – before the November elections. Warsh’s predecessor, Jerome Powell – who the administration pursued with trumped-up (pun intended) criminal charges – could tell him what the personal consequences of a falling out with Trump look like.

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