Why pick a hawk to do the work of a dove?
Macro Thinking…
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Inflation is a monetary phenomenon: During his tenure as a Fed Governor, Warsh was frequently the most hawkish voice on the board, emphasizing inflation risks even as the labor market struggled. His views don’t appear to have changed since then, arguing that “inflation is a choice” (channeling his inner Milton Friedman) and that the Fed should not be guided by contemporary views that high wages can spur inflation. Warsh characterized the supply side drivers of the post-pandemic price level increase as “that's not what inflation is, that's a one-time change in the price level of a widget.” This is likely how he views the current tariff environment as well, which means in the current backdrop inflation would not be his main focus, for now.
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Productivity is the answer: Warsh has been explicit in his view that the US is “on a verge of a productivity boom” and that combined with the administration’s focus and goals of deregulation, it could push economic growth 1 percentage point higher than the Congressional Budget Office’s forecast of long-term growth that sits ~1.8%. In addition, his views appear more generally skeptical that the Fed can “fine-tune” the labor market, which may stray from the current data dependent policy directive.
Fed Policy Shifts…
- Warsh's Rates Rap: Although Warsh is known as a hawk, and by extension viewed to be less likely to call for easy monetary policy, his current stance is that disinflationary forces from AI and deregulation could still result in the need for lower rates. In general, his view on neutral is still likely lower. Therefore, we believe he would motion for additional cuts in 2026 to support US growth while working to offset the more accommodative policy (via rate cuts) with an attempt to eventually reduce the Fed’s balance sheet. In terms of process, Warsh may also look to change aspects of forward guidance on rates (it’s possible the SEP dot projections get tweaked or even done away with). It’s also been televised that perhaps some of the money market plumbing tools change.
- QE reserved for break glass moment (means potential balance-sheet changes ahead): Warsh has advocated for a “regime change” that involves rapidly shrinking the Fed’s balance sheet. Generally, he has implied that the Fed balance-sheet should be used for emergencies and that the balance sheet needs lower duration instruments and more of a shorter duration portfolio (which also aligns with Treasury funding profile). In essence, Warsh has been critical of the Fed buying long duration, impacting credit conditions (via MBS QE) which should be the remit of the private sector. Warsh’s historical view is that the Fed should be less active in markets and instead focus on its core mission. Relying less on QE (aimed at long duration) means the Fed has a better asset/liability mix which in theory, won’t result in portfolio losses (which are unrealized but result in reduced or delayed payments to Treasury) if they raise rates to fight inflation in the future. In our view, we do not expect a Warsh-led Fed to quickly reduce the balance sheet as there would need to be many changes on bank regulation before that happens (so that banks can become the buyers of duration and key providers of mortgage credit).
- Fed independence back in the safe zone: In our view, picking Kevin Warsh as Fed chair should reduce fears that the Fed is all of a sudden lose about to lose its independence and that could help with anchoring of long-term rates over time. Warsh was at the Fed during/after the height of the GFC in 2008 (he served as a governor from 2006 to 2011) and thus can navigate through crisis periods. He also has a command of how the institution operates and how to interact with Fed staffers. This continuity of a Fed governor returning to the Fed should help smooth things over with staffers and help with policymaking at the Fed. It might also assuage some of the lingering concerns likely floating around the institution as well. And it’s possible that with a former Fed governor returning, perhaps Powell will stick to the tradition of retiring in May (his governor term ends in 2028 so he could stay on post after his chair role is over).
Market Thoughts...
- End of Fed liquidity overdone: Gauging by some asset classes, it feels like some think this is the end of the “Fed Put.” Gold and silver have had a major outsized reversal (granted from lofty levels) and it has been a mild risk off since the news of the Warsh announcement. The rates market has experienced both a bull/bear steepening of the curve with the front-end rallying on the prospects of rate cuts and the backend pricing-in Warsh’s view of the balance-sheet (i.e. DV01s will need to be financed by the private sector). We think its early days to be jumping to any conclusion and remain open-minded on what a Warsh Fed may look like/focus on. We think price action post announcement is just positioning tweaks that are taking place during month-end related flows.
- Future actions to watch (but not near-term market drivers): With modern banking evolving to faster rails, the need for shorter duration assets is likely how bond issuers evolve to meet collateral needs. So, it will be natural for the Fed’s balance-sheet to shift too. With stablecoins becoming a bigger topic (and also users/consumers of shorter duration assets) spilling over from a DeFi world to a TraFi world, it will be interesting to see how a Warsh Fed thinks about that and if there will be any coordination with Treasury. We also wonder how a smaller Fed balance-sheet will handle the MBS legacy portfolio. Will there be an asset-swap for shorter term USTs and an auction schedule placing MBS back into the private sector (think FDIC program but bigger and over time)? Also, will the GSEs get overhauled to take back that task from the Fed’s portfolio?
- Lastly, to answer our question – why pick a hawk to do a dove’s job? As mentioned, we think Warsh, as a former Fed governor has credibility, he has a solid background (and in many ways is similar to Powell in that he is not a traditional academic) and great connectivity to the business world and Wall St. Meanwhile, even though some are worried about him overhauling the Fed A.) We believe he would likely go through the standard process of Fed reviews (so it will take time for things to change) and B.) Warsh may first look to get buy-in/consensus to deliver on rate cuts before potential radical changes and C.) Things are likely on hold until after mid-terms. In the end the administration wants lower long-term rates, we think Warsh can help deliver on that. Given our initial assessment, we have not changed our Fed rate call and keep our rates forecast the same (after minor revisions post the January FOMC meeting).