Only two months into his tenure as chairman of the Federal Reserve, Kevin Warsh is leading the rate-setting Federal Open Market Committee (FOMC) at a time of unusually deep division over the direction of monetary policy in the world's largest economy.
It is unlikely this is how he envisaged the role when he first sought the position nearly a decade ago. Warsh lost out to Jerome Powell in 2017 in the race to succeed Janet Yellen. US President Donald Trump appointed him to replace Powell this year after becoming increasingly frustrated by the former chairman's refusal to lower interest rates.
Yet the case for cutting borrowing costs remains difficult while inflation continues to exceed the Fed's target. Annual growth in the central bank's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, has remained above its 2 per cent target for more than five years.
Federal Reserve divided
The committee itself is sharply divided. About half of FOMC members believe interest rates should rise this year, while the other half argue that policy is already restrictive enough to return inflation to target. Even among the more hawkish officials, however, many appear willing to wait for further evidence before advocating tighter policy. For now, the path of least resistance is to leave rates unchanged while assessing whether price pressures continue to ease. But the three dissents from July's rate decision underline just how fractured the committee has become.
Warsh's biggest challenge, therefore, is not simply deciding where interest rates should go next, but building consensus within an increasingly divided Federal Reserve while advancing an ambitious programme of institutional reform.
One early sign of that shift is the Fed's approach to communication. Warsh has long argued that central bankers should say less about the future path of policy. The statement issued after the June meeting ran to just 130 words, less than half the length of the communiqué released after Powell's final meeting in April.
A less communicative Federal Reserve could leave investors with greater uncertainty about policymakers' intentions, increasing volatility in bond markets as traders place more weight on incoming economic data and speeches by individual officials.
Market pricing before July's policy meeting illustrated how reduced guidance from officials can amplify uncertainty. Traders assigned roughly a one-in-three probability to a rate increase in the days before the decision. Markets are seldom that uncertain about the Fed's intentions immediately ahead of an FOMC meeting.
AI and the future of interest rates
Warsh's political skills are also likely to be tested as he seeks support for broader changes to the way the central bank operates. He has established five task forces to review the Fed's communications, its interpretation of economic data and other aspects of its policy framework.
The most significant of those reviews may be the task force examining AI and productivity. If officials conclude that AI is boosting productivity sufficiently to allow the economy to grow faster without generating inflation, they may also determine that the economy's equilibrium interest rate is lower than previously assumed. That view, broadly aligned with thinking among White House economists, would strengthen the case for lower policy rates in 2027 and beyond.
The evidence, however, remains inconclusive. The data do not yet provide convincing proof that AI has materially increased worker productivity, and economists remain divided over both the scale of any gains and the timing of their impact.
There is also a competing force at work. While AI could eventually reduce equilibrium interest rates by lifting productivity, its immediate effect has been to drive a surge in investment in data centres and computing infrastructure. Companies are borrowing heavily to finance that expansion, placing upwards pressure on equilibrium interest rates.
Whether the Federal Reserve ultimately revises its assessment of AI and interest rates may first depend on whether Warsh can build consensus among officials who remain divided over the state of the economy and the appropriate course for monetary policy.
Nick Stadtmiller is the Group Head of Research and Chief Economist at Emirates NBD
