Former New York Fed President Bill Dudley recently warned in a media interview that the Federal Reserve faces a significant risk of losing its anti-inflation credibility after repeatedly failing to achieve its 2% inflation target. Dudley noted that, in particular, the expectation that Kevin Warsh—the newly nominated Fed chair by U.S. President Trump—might cut interest rates against prevailing economic conditions under presidential pressure would further exacerbate the Fed’s credibility crisis.
Speaking on the ‘Surveillance’ program on Tuesday local time, Dudley stated: ‘Our inflation data has been significantly above the Fed’s 2% target for more than five consecutive years.’ ‘And there is a risk that inflation expectations could ultimately become fully unanchored.’
The former New York Fed president’s latest remarks highlight the substantial challenges facing newly appointed Fed Chair Kevin Warsh. Warsh is expected to preside over his first Federal Open Market Committee (FOMC) meeting as chair next month. He assumes leadership at a time when the Consumer Price Index (CPI)—a broad measure of inflation—has just posted its largest monthly increase since 2023. This follows sustained criticism from U.S. President Trump toward outgoing Fed Chair Jerome Powell for not easing monetary policy as aggressively as Trump had demanded.
Dudley noted that preliminary consumer sentiment survey results from the University of Michigan show rising long-term inflation expectations, consistent with the two-year inflation outlook recently emphasized by Federal Reserve Governor Christopher Waller. Since November 2022, despite interest rates remaining at or above current levels, the U.S. economy has continued to demonstrate resilience near full employment in nonfarm payrolls, leading Dudley to increasingly question whether the Fed’s monetary policy is truly restrictive at all.
Federal Reserve Governor Christopher Waller—who holds a voting seat on the FOMC during his term and was nominated by President Trump—earlier this year advocated for rate cuts to safeguard the U.S. labor market. However, he stated last Friday that the likelihood of the Fed’s next move being a rate hike is now equal to that of a rate cut.
Dudley added that the neutral interest rate—the level that neither stimulates nor restrains the economy—may structurally be higher than what Fed officials currently assume. In the interview, he also referenced the unprecedented investment boom driven by artificial intelligence technologies and the continuously rising U.S. government debt levels, with the latter particularly reducing the pool of national savings available for investment across the financial system.
Dudley stated that overall, Kevin Warsh formally taking the helm at the Fed, combined with President Trump’s longstanding calls for lower interest rates, has further complicated the credibility challenges facing the central bank.
Dudley remarked: ‘If the Fed’s independence is not called into question, inflation expectations are more likely to remain well anchored.’ ‘Right now, the case for cutting rates is actually very, very weak.’
Rate-cut fantasies give way to hawkish policy bets! The U.S. Treasury yield curve flashes a ‘Higher-for-Longer’ warning.
In fact, following the surge in inflation data—triggered by the Iran war in the Middle East and marking the largest increase since 2023—global bond market traders are now pricing in a near-certainty that the Fed will begin raising rates before December, with markets almost fully pricing in a 25-basis-point rate hike by then. This represents a sharp reversal from just three months ago, when markets were betting on deeper rate cuts under a Warsh-led Federal Reserve.
This shift reflects the combined impact of geopolitical turmoil, U.S. economic resilience, and the AI investment boom propelling equities higher—all factors intensifying concerns that inflation could remain persistently above the Fed’s 2% target for an extended period.
In a highly volatile trading week, the two-year U.S. Treasury yield—the most sensitive gauge of Fed policy expectations—climbed to 4.14% last Friday, its highest level in over a year and nearly 40 basis points above the upper bound of the Fed’s current policy rate range. The 30-year Treasury yield briefly touched 5.2% last week, reaching that level for the first time since 2007, before retreating to 5.06%. Meanwhile, the 10-year Treasury yield, known as the 'global anchor for asset pricing,' rose to around 4.7%—its highest since January 2025—before easing back to approximately 4.5%.
Bond markets no longer fully believe that global central banks, including the Federal Reserve, can smoothly restart rate cuts. Instead, through rising short-end yields and a flattening yield curve, they are forcing policy rate expectations to reprice toward a 'higher-for-longer' stance or even a potential return to a hiking cycle.
Bond market traders and interest rate futures traders have significantly increased their bets that, under new Fed Chair Volcker, the Federal Reserve may keep its benchmark rate at elevated levels for longer—what is known as a 'higher-for-longer' hawkish monetary policy path—due to inflation pressures re-emerging in consumers’ view.
Andrew Ticehurst, Senior Strategist at Nomura Securities, stated: 'Both data and political factors indicate that downward pressure on the Fed to cut rates is significantly diminishing. The front end of the yield curve has been repricing sharply upward, reflecting increasingly forceful market bets on rate hikes.' He added that Trump’s remarks about allowing Warsh to 'do what he wants' are also contributing to this shift.
The persistent failure to achieve the 2% inflation target puts Volcker’s proposed path of 'rate cuts plus balance sheet runoff' under real-world scrutiny.
Undoubtedly, Dudley’s assessment aligns with Volcker’s argument of 'restoring the Fed’s credibility': both fundamentally hold that if the Fed fails over the long term to bring inflation back down to 2%, its policy credibility and ability to anchor inflation expectations will be impaired. Dudley explicitly warned that U.S. inflation has remained above the Fed’s 2% target for more than five consecutive years and that if the Fed’s independence comes under political pressure, inflation expectations could more easily become unanchored. He also deemed the current rationale for rate cuts 'very, very weak.' This is consistent with Volcker’s post-appointment objective of rebuilding the central bank’s anti-inflation credibility—but it also implies that Volcker will find it difficult to smoothly implement his long-held stance of 'rate cuts plus balance sheet runoff' amid resurgent inflation, oil price shocks, and widening long-term Treasury yields.
Rate cuts would undermine anti-inflation credibility, while balance sheet runoff could further push up term premiums and long-end yields at a time when U.S. Treasury supply is rising and demand for government debt is markedly weakening—thereby sustainably elevating long-term borrowing costs across U.S. financial markets. Although 'rate cuts plus balance sheet runoff' can theoretically be framed as 'front-end easing and back-end normalization,' under current macroeconomic conditions, markets are likely to interpret it as conflicting policy objectives.
A more realistic path is this: if Volcker aims to restore credibility, he will most likely need to prioritize maintaining hawkish credibility in the near term—meaning he should at least avoid rushing into restarting rate cuts and adopt a more cautious stance on the pace of balance sheet runoff. Fed Governor Waller recently stated that inflation risks imply the Fed should refrain from continuing to signal rate cuts and should not rule out hinting that its next move could be a hike.
Nomura Securities has recently withdrawn its expectation for rate cuts in 2026, citing high oil prices stemming from the Iran conflict and record AI-related capital expenditures that are generating inflationary and financing pressures. Nomura had previously projected that the Fed would cut rates by 25 basis points each in September and December but now emphasizes that inflation remains highly sticky and expresses skepticism about whether policymakers can reach consensus in support of rate cuts. Wall Street heavyweights such as Morgan Stanley and Barclays have already ruled out any Fed rate cuts this year, primarily due to higher oil prices linked to Middle Eastern geopolitical tensions and the continued resilience of U.S. economic growth.
Editor/Lambor