Inflation and Policy Outlook Under Warsh

The Inflation Outlook and Fed Policy Under New Leadership

Inflation is back above 4% and the Federal Reserve faces its first major test under Kevin Warsh. The May Consumer Price Index came in at 4.2% year over year, the highest reading since April 2023. The primary culprit was a 7.0% jump in gasoline prices, which alone accounted for more than half of the monthly increase. The rest of the picture was mixed, with electricity and airline fares pushing higher while new vehicles and medical costs pulled in the other direction.

Is This the Peak?

There are reasonable grounds to believe May represents the high point of the current surge, though the conclusion rests on assumptions that are far from guaranteed.

Energy is the biggest variable. Gasoline has already fallen from its May 21st peak of $4.56 to $4.07 per gallon, and a recently announced interim peace deal between the United States and Iran could reopen the Strait of Hormuz to oil traffic, putting further downward pressure on energy prices. Both sides have strong incentives to make it work, but meaningful obstacles remain.

On tariffs, two court rulings have struck down the administration's IEEPA tariffs, bringing the effective average tariff rate down from 11.5% of goods imports in late 2025 to an estimated 7.8% today. New tariffs are being pursued under Section 301 but face likely legal challenges. The baseline assumption is tariffs settle around 7.5% of imports going forward, a meaningful reduction in price pressure compared to last year.

Shelter costs, which make up 33.5% of CPI, are also cooling. Private market data shows new lease rents ranging from down 1.7% to up just 1.8% year over year. As those real world declines work their way into official measurements over the next year, shelter inflation should provide meaningful relief to the overall index.

Critically, wages are not accelerating. Average hourly earnings rose just 3.45% in May, the second smallest gain in five years, and real wages declined for a second consecutive month. Without a wage price spiral, inflation is far less likely to become entrenched. The baseline forecast is CPI falls to 3.3% by December 2026 and drops to 1.8% by May 2027.

Which Inflation Number Matters?

Warsh has signaled a preference for the trimmed mean, which currently reads 2.4%. But headline CPI is 4.2%, headline PCE is 4.0%, and core PCE is 3.3%. Every available measure is above the Fed's 2% target. The trimmed mean is simply the most favorable reading on the board, and even it is not at target. The average household cannot exclude gasoline or groceries from their budget because they are volatile, which is why relying on trimmed measures to justify rate cuts remains a credibility risk for Warsh.

What Happens at Wednesday's FOMC Meeting

The Fed is expected to hold rates steady and remove any projected rate cut from its 2026 outlook. Warsh, despite dovish language during his confirmation hearings, is unlikely to break from the committee consensus on his first meeting. No Fed chair in history has publicly voted against the FOMC majority on day one. He is however expected to push back against rate hike expectations that futures markets have begun pricing in for later this year, and on that he is likely to prevail.

What This Means for Investors

With monetary policy on hold and fiscal deficits accumulating, long term interest rates are likely to drift higher, driven more by government borrowing than Fed decisions. High quality bonds should be held for income and diversification rather than price appreciation. Rate cuts are more likely a 2027 story than a 2026 one.