President Donald Trump tapped Kevin Warsh as his Federal Reserve chair in the
hopes of finally securing the lower borrowing costs he has longed for.

The bond market might overrule both of them.

As Warsh takes the helm of the central bank following a White House ceremony
on Friday, global bond yields are surging, with the war in Iran pushing up
inflation and making interest rate cuts look less and less likely. In the last
week, rates on 30-year U.S. government debt at one point touched their highest
level since 2007. Investors — and a majority of Fed officials — are now giving
real consideration to the idea that the central bank might have to raise rates
before the end of the year to keep inflation in check.

“There’s no space for rate cuts” is the message from rising bond yields, said
Tim Duy, chief economist at SGH Macro Advisors.

The spike in borrowing costs is already amping up pressure on the new Fed
chief as he faces the possibility of both chaos in markets and wrath from the
Oval Office. Trump, who mercilessly criticized outgoing Fed Chair Jerome
Powell for not cutting rates, has suggested in recent interviews that he might
not expect immediate action from Warsh, given the economic fallout from the
Middle East conflict. Still, elevated market rates will test his patience,
especially as the midterm elections in November approach.

How long of a honeymoon Warsh gets from presidential pressure is one of the
key questions facing the new Fed chair, who previously served on the central
bank board from 2006 to 2011, a period when he played a role in dealing with
the financial crisis.

Warsh, who has previously said productivity gains from artificial intelligence
could help stifle inflation and allow rates to come down, on Friday expressed
his commitment to the central bank’s mandates of stable prices and maximum
employment.

“When we pursue those aims with wisdom and clarity, independence and resolve,
inflation can be lower,” he said. “Growth stronger. Real take-home pay higher.
And America can be more prosperous.”

Trump, for his part, suggested he intended to be hands-off on Warsh for the
time being.

“Honestly, I really mean this … I want Kevin to be totally independent,” he
said. “I want him to be independent and just do a great job. Don’t look at me
or anybody.”

Still, his praise of Warsh was an implicit caution against too-high rates.

“Thankfully, unlike some of his predecessors, Kevin understands when the
economy is booming, that’s a good thing,” he said. “We have some debt we would
like to take care of. The way you do that is through growth.”

“We want to stop inflation, but we don’t want to stop greatness,” Trump added.

Warsh’s predecessor, Powell, is sticking around on the Fed board for now, a
decision he has attributed to the president’s legal attacks on the central
bank. That creates another awkward dynamic for Warsh, though Powell has said
he intends to keep a low profile and wants to work constructively with the new
chair.

At his final press conference as central bank chief last month, Powell said
the institution would want to see energy costs coming down from their peak and
tariff-related price spikes fading “before we even thought about reducing
rates.”

Oil-related inflation fears are piling onto other trends that are pushing up
borrowing costs, including massive budget deficits that have led to a glut of
public debt for investors to absorb, forcing governments to offer investors
ever-higher yields.

Good news is also contributing to the problem: The artificial intelligence
spending boom and robust corporate earnings have increased expectations for
healthier growth — a dynamic that also keeps rates higher, as government
borrowing competes with other investment options. AI spending has also helped
push up software inflation in the short term.

None of these factors seems to be fading quickly, which means the U.S. could
be facing just the situation the Trump administration wanted to avoid: higher
mortgage rates and higher debt costs for the U.S. government.

Subadra Rajappa, head of U.S. research at Société Générale, described it as
“an environment of sticky high interest rates” combined with the possibility
of even more debt, given huge bumps in defense spending being proposed by the
Trump administration.

“That all adds up over the longer run,” she said.

Stephen Miran, a Fed governor who is departing on Friday because Warsh has
replaced him on the central bank’s board, is something of an outlier: Miran,
who previously served as Trump’s chief economist, argues the Fed can cut rates
because its policy decisions take time to feed through to economic activity,
and longer-term trends, such as declining population growth, will help keep
inflation tame.

“The market for sure is rapidly changing with respect to the war in Iran, and
as that develops, the market will follow,” he said. “Even if the war stays bad
for a while, I think the market is a little too enthusiastic about rate hikes
relative to where inflation is going and relative to where the labor market
is.”

But whether Warsh can convince his colleagues to cut rates at some point this
year depends at least in part on the length and severity of the war in Iran,
which remains in flux nearly three months into the conflict.

Fed board member Christopher Waller said in remarks earlier Friday that “a
rate cut is no more likely in the future than a rate increase” when
considering the central bank’s next move, but that his current position is
that rates should stay where they are for now.

If higher energy costs weigh on the private sector enough to spur a rise in
layoffs, which at this point remain low, the Fed might eventually choose to
ease off on the economy. Yet the job market has held up, even exceeding
expectations over the last two months.

Inflation, meanwhile, has proven troublesome beyond just the price increases
spurred by higher oil prices and tariffs, which could suggest a role for the
Fed in the form of rate hikes.

Together, those indicators paint a picture that might make bond investors
nervous if the central bank were to cut rates — both because they might
register it as a mistake and because it could heighten fears that the Fed is
being driven by political pressure from the president rather than decisions
guided by what’s best for the economy.

“If you really do make a policy error, and it’s blatant, the market’s going to
react,” Duy said. “The data has just stripped [Warsh] of the capacity for a
rate cut.”