The Federal Reserve's internal dovish faction collectively shifts to hawkish, Wash's debut leaves "caught between two stools"

Byline: Long Yue

Source: Wall Street Insights

Inside the Federal Reserve, “dovish” officials—who once strongly pushed for rate cuts—have recently, one after another, said they do not rule out rate hikes, including Waller and others. Within the committee, there is virtually no one left advocating for rate cuts. The Fed’s first outing under Chair Wash, or could send a signal: the Fed’s next move may be a rate hike.

Trump picked him to cut rates, but soon after he took office, his colleagues began discussing rate hikes.

The latest in-depth report by The Wall Street Journal is timed just before the first interest-rate meeting to be chaired by the new Fed Chair, Kevin Warsh. Timiraos, a long-time reporter focused on the Fed, is viewed by the market as the “Fed’s mouthpiece.”

Timiraos wrote that Warsh walked into the meeting room at an extremely awkward moment. Last year, he publicly argued for rate cuts—and it was precisely this stance that won him Trump’s favor. However, after he formally took office, the direction of internal discussions at the Fed quietly flipped—from “when to cut” to “whether to raise.”

This reversal did not happen overnight. So far this year, U.S. inflation has risen instead of falling and has already surpassed 3%; the job market has regained strength; supply bottlenecks brought by the AI construction boom and oil prices lifted by the Iran war have continued to stoke prices. The reasons that once supported expectations for rate cuts have been disappearing, one after another.

What Warsh faces is a committee he did not personally assemble, a forecasting tool he has long criticized, and a policy direction that runs counter to the wishes of the president who appointed him. This debut is destined to be far from easy.

How do doves turn into hawks?

The clearest indication comes from the attitude shift of Christopher Waller, a Federal Reserve Governor.

Waller spent all of last year worrying about weakness in the job market. Even in January this year, he supported a rate cut despite opposition from most of his colleagues. But just last month, he publicly said that the latest data “has pushed me in another direction.” He made it clear that he supports removing the “dovish bias” from the statement, and he said bluntly: “I can no longer rule out the possibility of a rate hike at some point in the future.”

When it comes to discussions in the market about a rate cut in September, Waller’s response was straightforward: “As a serious central banker, you can’t seriously talk about that.”

Moderates are also wavering

If Waller represents the dovish camp shifting, then the changes from Governor Lisa Cook show that even the “middle ground” is starting to loosen.

Cook is not hawkish. Last month, she still said that keeping rates unchanged was the right choice, and the baseline scenario remained that inflation would ease on its own. But she added a condition—one that would have been almost impossible for her to be in a year ago: she said that if inflation “does not show up in time,” she is “prepared to raise rates.”

The concern behind this is that inflation, which has stayed above the target for five consecutive years, may have started to affect how businesses and workers set prices and negotiate wages—creating a self-reinforcing expectation.

Hawks have been waiting for this day

The hawks on the committee have, in fact, been unhappy for a while.

At the end of last year, when the Fed cut rates, Cleveland Fed President Beth Hammack, Dallas Fed President Lorie Logan, and Minneapolis Fed President Neel Kashkari all raised objections to the decision, arguing that the rationale for easing simply did not hold up.

In April this year, the three of them once again coordinated. This time, they were not opposing the interest-rate decision itself, but rather the wording in the statement that suggested “the next step is more likely to be a rate cut”—they demanded its removal to make clear that a rate hike is also a possible option.

Now the data is further tilting in their favor. This month, Hammack said that keeping rates unchanged is reasonable “for now,” but “if recent trends continue, action may soon be needed.” Logan went further: “I’m increasingly worried that it may be necessary to raise rates later this year.”

The hawks also put forward an argument worth paying attention to: as inflation rises, the inflation-adjusted “real interest rate” is actually falling, which means the degree to which Fed policy restricts the economy may be lower than the surface numbers indicate. In other words, simply “standing pat” is, in a sense, already accommodating.

Warsh’s dilemma

This Wednesday, the Fed is expected to keep the benchmark rate unchanged at 3.5% to 3.75%. But the real focus is on two places.

First is the wording in the statement. The “dovish bias,” which has been retained for months—signaling that the next step is more likely to be a rate cut—is expected to be removed, meaning that the probabilities of rate cuts and rate hikes are now seen as equal.

Second is the quarterly “dot plot.” In March, a dozen or so officials expected at least one rate cut this year. This time, it is expected that most officials will show no change for the year, and some may even mark a rate hike on the chart.

Warsh himself has long criticized the Fed’s overreliance on “forward guidance,” including tools like the dot plot. He could choose not to submit his own forecast, or he could strip related hints from the official statement. But Timiraos points out that this operational difference matters little to investors—they will read the substance directly. The person who truly cares about this difference is the president who wants to see low rates.

A comment from Chicago Fed President Austan Goolsbee last month may best capture the situation right now: “We are facing a pretty serious inflation problem forming, but the labor market remains basically stable.”

The result is that almost nobody on the committee is advocating for rate cuts anymore. Warsh’s debut could send a signal— the Fed’s next move may be a rate hike. And all of this will be conveyed through the tools he has criticized for years, by a committee that he did not personally select, moving toward a direction his appointer does not want to see.