Interest rate storm sweeps the Federal Reserve! The roadmap for rate cuts has been invalidated. With the new official in Washington, "not raising rates" is considered a victory.

Kevin Wash's ability to emerge victorious in the competition for the Chairmanship of the Federal Reserve partly lies in his mapped out path towards lower interest rates. However, now, the new head of the Federal Reserve is facing a completely different situation: as peer decision-makers are warning about the resurgence of inflation, how will he contain the sudden shift in market expectations towards higher interest rates. Notably, the new data released on Thursday has exposed this challenge. The data shows that the inflation indicator favored by the Federal Reserve rose by 3.8% in the 12 months ending in April. This is the highest level since 2023, exceeding the Federal Reserve's target of 2% by nearly two full percentage points. Federal Reserve observers say that the window for rate cuts has closed, influenced by the energy shock triggered by the Iran war. This means that for Wash, simply maintaining the current interest rate level may already be considered a victory. Stephanie Ross, chief economist at Wolfe Research, said, "The market now has absolutely no appetite for rate cuts." "Wash must be able to dispel the already digested expectations of rate hikes - this is his biggest challenge this year." How Wash guides the discourse around interest rates in the coming months may set the tone for his leadership style and shape his ability to prove to the outside world that he is defending the independence of the Federal Reserve. Although U.S. President Trump has expressed hope that Wash would act independently as the Chairman of the Federal Reserve, political pressure to lower interest rates continues to simmer. Just hours after presiding over Wash's swearing-in ceremony last week, Trump stated that he expects rates to come down "very quickly." Expectations are changing As expectations around interest rate paths shift, it is predicted that even if the Iran conflict ends, energy costs will remain high in the coming months. Additionally, the surge in investments flooding into the field of artificial intelligence (AI) is also pushing up broader inflation pressures. All these factors have prompted a series of Federal Reserve officials to issue warnings in recent weeks, stating that the Fed can no longer hint that rate cuts may be their next move. Instead, they are more inclined to warn of the risks of policy tightening - a dramatic turnaround compared to earlier this year when officials predicted further policy easing in 2026. In an interview on Thursday, St. Louis Fed President Alberto Musalem said that the possibility of raising rates in the coming months "must be greater than zero." In addition, New York Fed President John Williams said that he believes the current policy is in a favorable position to address the impacts of the war. It should be noted that these warnings do not mean officials intend to raise rates in the short term. The end of the Middle East conflict will give decision-makers time to assess its impact, and the labor market stuck in a "low hiring, low firing" cycle has also become a reason to oppose tightening policies. "We believe that even before Kevin Wash assumed the helm of the Federal Reserve, the threshold for rate hikes was higher than that for rate cuts," said Robert Sogen, chief U.S. economist at PGIM. However, it is obvious that inflation has entered a range that few foresaw at the beginning of the year. The Consumer Price Index (CPI) for April saw the largest increase since 2023, prompting investors to shift their bets from rate cuts to rate hikes. Long-term inflation expectations have also been impacted. According to the University of Michigan's May consumer survey, consumers expect prices to rise annually by 3.9% in the next 5 to 10 years, up from 3.5% in April, and hitting a new high in seven months. Derek Tang, an economist at LH Meyer/Monetary Policy Analytics in Washington, said, "Wash now not only cannot find reasons for rate cuts, but instead has to expend energy to fend off increasing demands from peers and the public to tighten policy, or at least maintain the status quo." Policy easing may have inadvertently fueled inflation There are other reasons suggesting that current policies may have inadvertently fueled inflation rather than cooling it. Matt Luzzetti, chief U.S. economist at Deutsche Bank, warned that the Fed may have overly cut rates in 2024 and 2025, leading to excessively loose policies. Concerns over this become more acute as inflation rises, pushing up the level of interest rates seen as "neutral policy" (neither restricting nor stimulating the economy). "If you do nothing, you're actually easing policy," said Fabio Natalucci, CEO of Andersen Financial and Economic Research Institute, who previously worked at the Federal Reserve and the International Monetary Fund(IMF). Most Federal Reserve officials believe that current policies are around neutral level or slightly above neutral level. Internal tension within the Federal Reserve may peak at the June policy meeting, where officials may remove the so-called "dovish bias" from the policy statement. They will also submit new forecasts, which may include higher inflation levels, and at least postpone the expected timeline for future rate cuts. One particularly notable example is: Federal Reserve Governor Christopher Waller, who strongly advocated for rate cuts in 2024 and 2025, now supports explicitly stating that the next rate move is equally likely to be a rate hike or a rate cut. "The reality is that inflation has become sticky," said Diane Swonk, chief economist at KPMG. "Wash is stepping into a shift in public discourse."