Kevin Warsh assumed office as US Federal Reserve chairman on Friday, with heightening inflation fears over a prolonged Iran war pushing up odds of higher interest rates.
Mr Warsh takes charge of the world's most influential central bank at a precarious time for the American and global economies.
Inflation is accelerating as oil prices remain above $100 a barrel due to supply disruption in the Middle East, with a prolonged conflict expected to have a greater impact on consumer prices and economic growth.
The US and Iran are at an impasse over how to end the war. US Secretary of State Marco Rubio on Friday said “a little bit of movement” was made over a possible deal, although he rejected the idea of Tehran implementing a tolling system in the Strait of Hormuz, where traffic remains at a virtual standstill.
Bond market signals
Heightened inflation fears are putting increasing pressure on US Treasuries. Bond markets are now signalling that interest rates, which currently sit between 3.50 per cent and 3.75 per cent, are not high enough.
The two-year Treasury yield, which is closely linked to Fed monetary policy, at 4.1 per cent is well above the Fed's target range. The yield on the benchmark 10-year Treasury neared 4.7 per cent earlier week while the 30-year Treasury yield briefly touched 5.19 per cent, its highest level since 2007.
Government data this week showed Saudi Arabia and the UAE – typically among the largest buyers of US government debt – trimmed back their holdings of Treasuries in March. Saudi Arabia cut its holdings of US Treasuries by $10.8 billion that month, while the UAE trimmed its portfolio by $5.8 billion to $114.1 billion.
Japan, the largest foreign holder of US government holdings, also joined foreign governments in cuts to US Treasuries as the Iran war forced central banks to defend their local currencies. Total foreign holdings fell from $9.49 trillion in February to $9.25 trillion in March, although the UAE and Saudi Arabia's holdings remain at historically high levels.
Rate expectations
Traders are also lowering their rate-cut expectations. Recent CME Group data now shows roughly 22 per cent of traders believe the Fed is as likely to raise interest rates as they are to cut them.
That would likely put Mr Warsh at odds with President Donald Trump, who has repeatedly attacked the Fed and departing chairman Jerome Powell for not delivering aggressive interest rate cuts.
In an apparent shift in tone, Mr Trump said during a swearing-in ceremony at the White House on Friday that he wants Mr Warsh to be “totally independent”.
“Don't look at me, don't look at anybody,” Mr Trump said during a swearing-in ceremony at the White House.
The Federal Reserve has kept interest rates unchanged this year, citing the conflict in the Middle East. The UAE Central Bank, which follows Fed policy moves because of the dirham's peg to the dollar, has also kept its key rate at 3.65 per cent.
Minutes released from the Fed's April meeting on Wednesday suggested the debate within the central bank is turning towards the possibility of a rate increase. Several Fed officials still believe a rate cut is possible if inflation moderates again or if there is a clear weakening in the labour market.
“A majority of participants highlighted, however, that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 per cent,” the minutes read.
Speaking in Germany, Fed Governor Christopher Waller, an influential member on the rate-setting committee who previously advocated for lowering interest rates, said talks of rate cuts now are “crazy”, suggesting his position on the matter has flipped.
“I can no longer rule out rate hikes further down the road if inflation does not abate soon,” he said.
Mr Powell has said he will continue serving his remaining time as a Fed governor until a Justice Department's investigation into him is “well and truly over”.
He has previously accused the investigation into his testimony regarding project cost overruns at the Fed's headquarters as a pretext to pressure him to cut rates.
