Warsh's Rate Dilemma: Can Fed Tackle Supply-Driven Inflation?

The Federal Reserve is facing pressure to act on inflation, but its tools are limited when it comes to combating supply-driven inflation. Kevin Warsh, the new Fed chairman, has vowed to get inflation back to 2%, but some investors suspect that raising rates will not be enough. The war with Iran and high tariffs have derailed energy supplies from the Middle East, lifting prices on diesel, gasoline, and jet fuel.

Economists warn that raising rates could tip over the stock market and push the job market into a recession. Former Fed Chair Janet Yellen argued that the default strategy for the Fed should be looking through supply shocks, rather than being tempted into rate hikes. Market-based measures of inflation expectations are not near the danger zone.

The AI boom is also driving up prices, with memory and component costs rising due to massive investments in infrastructure. Moody's estimates that about 0.66 percentage points of forecasted inflation at the end of this year will be due to the Iran war, while another 0.17 percentage points comes from tariffs and trade restrictions.