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Wednesday, the market will hear from the new Chairman of the Federal Reserve, Kevin Warsh. Trump favored Warsh for his experience, but more so for his rate cutting commitment. With inflation elevated and labor conditions tight, markets have priced in rate hikes over the coming year, creating conceptual conflicts in need of resolution. Either Warsh sticks to his script and guides rate expectations lower or he pivots and adopts the market’s instruction. There are rational arguments to be made for both. The markets always test new Fed Heads. We will find out Wednesday whether Mr. Warsh is the professor… or the pupil.
On June 17, new Fed Head Kevin Warsh will hold his first post-FOMC press conference to comment on the rate decision, his outlook for employment and inflation, and his governance plans for Federal Reserve activities. Markets love to test new Fed Chairs. Donald Trump selected Kevin Warsh mainly for his lower interest rate bias. And yet, from the date of Warsh’s nomination, the 2-year Treasury yield (the market’s best proxy for future Fed policy decisions) has increased from 3.5% to 4.13%, above the current policy rate of 3.75%. While The Chair may want lower rates, The Market expects higher rates. This conflict requires resolution. We will not receive full resolution on Wednesday, but the resolution process will begin. To help frame the arguments let’s examine current conditions for both of the Fed’s congressional mandates, price stability and maximum employment.
Price Stability
Fed Head Ben Bernanke established a 2% inflation target for the Federal Funds rate in 2012. Prior to that, the Fed didn’t have a numerical inflation bogey. Post that decision, markets calibrated economic and interest rate expectations around the 2% objective. Unfortunately, inflation bedevils the Fed by continuously undershooting and overshooting the 2%:
Pre-Covid stimulus spray, inflation held stubbornly below 2%, inspiring Fed Head Powell to loosen the target to an “average” of 2% in August of 2020. Since then, inflation has averaged 3.6%. After some encouraging disinflation in early 2025, the combination of the AI buildout boom, immigration controls, tariff impositions, and oil blockades has pressured inflation higher. When adding back food and energy, excluded from the Fed’s preferred measure due to volatility, the inflation story worsens:
For the year ending in May, overall US consumer price inflation rose 4.2%. Therefore, while the Fed may have a 3.3% policy inflation problem, they have a 4.2% headline inflation problem, making a solid case for the Fed to raise rates, not lower them.
For Warsh to argue for lower rates, he must identify more durable disinflationary forces within the data. Housing inflation trends add some assistance and represent 18% of the Fed’s preferred inflation measure, deserving reference:
Warsh has also spoken to the disinflationary impact of AI productivity gains across the economy. While we support this observation, the economy must build the AI before benefitting from the AI, which implies shortage driven inflation in the near term (commodities, tech hardware, utility capacity, etc.) in exchange for productivity disinflation in the longer term. If the Fed overreacts to the near-term inflation, it could forestall more durable longer-term economic benefits by restraining AI Capex. For now, the productivity argument appears real and intact:
Ignore recession driven productivity gains as distorted data. The last true productivity surge occurred during the late 1990’s. During this period (1995-2000) core inflation averaged 1.7% and fell as productivity rose. There is certainly modern historical precedent for Warsh’s productivity argument. I would expect him to harp on this next Wednesday.
Lastly, Warsh may site the “transitory” nature of current inflation. 60% of the inflationary gain last month can be attributed to war stoked energy inflation, any war relief should provide inflation relief. Also, AI Capex may cool at the margin as companies reconcile spending with returns, rationalizing shortages. Lastly, inflationary base effects may provide optical relief as June, July, and August 2025 ran hot and those numbers will fall away with each upcoming release. Taken together, longer term inflation expectations appear well within normal ranges, having actually fallen recently:
Maximum Employment
As we have long argued, gains in productivity do not mean fewer jobs and lower wages as frequently feared, but more jobs and higher wages as frequently proven. Nothing punctuates this point better than the comparison of job opening data for software developers versus the economy at large:
Furthermore, the AI jobs apocalypse remains overdue as the US economy has blown away hiring expectations so far this year:
Overall, the US unemployment rate sits at 4.3%, well within the Fed’s range of “maximum employment.” Additionally, the unemployment rate for the youth cohort most “AI at risk” registers at 7.2%, which seems high until you compare that rate to itself over time:
So, the good news is that jobs seem plentiful for all… even the youth and software developers. Therefore, the Fed has met its maximum employment mandate. The bad news is that tight labor markets can often metastasize into inflation up-force. Fortunately, despite employment gains, overall employment inflation, while still elevated from COVID levels, appears largely contained:
The employment cost index rate of 3.3% is the lowest year-over-year growth rate since 2021. For the Fed, a 3.5% employment cost index minus a 2.5% productivity growth rate leaves a unit labor cost inflation rate of 1%. Historically, this is unusual as labor inflation rates often exceed headline inflation rates. That is not the case currently and helps support Fed Head Warsh’s dovish stance despite tight labor markets.
While SpaceX made the story of the week, the fireworks over Warsh’s first official press conference interests us more, and will matter more to longer term investors, overall. Popcorn popping!
Related: AI May Be a Supercycle, but It’s Still a Cycle
Sources: Federal Reserve Bank of St. Louis, Yardeni Research