By year end, the promise of lower rates became a baseline requirement rather than a winning argument for landing the Fed Chair job. Warsh recognized that to win, he needed to offer something the others didn't: a target for Trump’s frustration.
Well played sir, tip of the cap. Promise lower rates as part of the positioning but really hammer the Fed itself. Target Jay$. Warsh told Trump what he wanted to hear, and it landed him the gig.
Let’s dig into the 3 most important things to know about Warsh.
#1 - He Hates QE
The single most important thing to know about Warsh is that he really really really opposes QE. He called it “reverse Robin Hood”, inflating assets without a corresponding increase in wages. Pretty darn spot on, right?
Warsh was on the Board of Governors during the GFC. He reluctantly supported the initial rounds of QE, but mostly as an expression of solidarity behind Bernanke. "If I were in your chair, I would not be leading the Committee in this direction... I will support [the policy] today because of my respect for your leadership and for the institution, but I am extremely skeptical of the benefits.”
The Fed’s balance sheet ballooned from $800B to $9T post-GFC. Since mid-2022, the Fed has been reducing its holdings to $6.6T, but paused further reductions in December.
That pause was in response to liquidity issues bubbling up and this is where markets get a little nervous. If the plumbing breaks, will Warsh still be opposed to Fed intervention?
The Fed has an explicit dual mandate on jobs and inflation,but an unspoken super-mandate to support financial stability. Warsh will push immediately to ramp up balance sheet reductions. Markets mustprice in a reduced likelihood of a Fed put under Warsh.
In general, I agree with reducing the Fed’s balance sheet and its reliance on bond buying. After the GFC, the Lender of Last Resort became the lazy go to and it distorted markets. But I’m not hardliner when it comes to weighing the balance between jobs and inflation…
#2 – He is an Inflation Hawk
One of his favorite lines is, “Inflation is a choice”. That usually comes right before or after attacking Fed decisions over the last 10 years.
On April 9, 2009, the Unemployment Rate was 9.0% while Core PCE was just 0.8%.“I continue to be more worried about upside risks to inflation than downside risks". Core PCE would average 1.5%for the next decade. Woof.
“JP, he’s not the only person to be wrong about inflation…”
Fair, but it’s worrisome that more than 5mm Americans had lost their job in the prior year when he said that. Despite concrete evidence that the labor market had fallen apart, he was more focused on the hypothetical fear of inflation. Being married to a billionaire has its advantages, I guess…
Over the subsequent 10 years, unemployment averaged 6.7%. In fact, we wouldn’t see full employment for another 8 years. Like all economists, he must be subject to the frailties of human nature because he didn’t change his mind until the unemployment rate was almost 10%.
Like JMo, he cried inflation for more than a decade and then got his moment in the sun in 2022. “See! I told you!”
If the wheels on the labor market fall off, will he continue to focus more on the inflation side of the mandate?
#3 – Changes at the Fed
You can’t call for regime change and then not change anything.
Warsh is opposed to forward guidance. He has called the Summary of Economic Projections (SEP aka blue dots) “deeply counterproductive”. Greenspan preferred Fed officials stay quiet so that the impact of policy changes would have a more dramatic effect on the market. Warsh has argued for a more“opaque” Fed.
Warsh also wants less reliance on economic models. In a speech last year to the G-30, Warsh dismissed Fed forecasts as “another distracting Fed preoccupation. Economists are not immune to the frailties of human nature. Once policymakers reveal their economic forecast, they can become prisoners of their own words. Fed leaders would be well-served to skip opportunities to share their latest musings.”
He has argued that the Fed has“drifted” from its primary mission of setting interest rates. I agree. Where we disagree is that he blames the Fed, whereas I blame Congress for getting too comfortable asking the Fed to cure all ills.
Here’s where things get interesting…how successful can Warsh be at implementing his changes? In order toland the job, he had to attack the Fed. How does the team at the Fed feel about that? He is skeptical of the Fed’s models…do you like having your own models attacked?
Dallas Fed President Lorie Logan literally knows more about the financial plumbing than anyone else in the country. She spent more than 20 years in the Markets Group at the NY Fed. She led the SOMA for the FOMC.
If she doesn’t vote for lower rates, will Warsh dismiss her input on system liquidity?
The FOMC is a Democracy
The FOMC requires a simple majority for pretty much every decision, soWarsh can’t come in and unilaterally implement sweeping changes.
Eliminate the blue dots? Vote
QT? Vote
Lower rates? Vote
It sounds like Lisa Cook isn’t going anywhere, while Powell remains the wildcard after May. Warsh will take Miran’s seat on the Board, and Miran was already calling for 2% rates, so Warsh doesn’t change the math in the near term.
And since Warsh spent a lot of energy attacking the Fed in order to land the job, I assume there will be some natural resistance.
There’s a non-zero chance the Fed Chair dissents from the rate decision. That hasn’t happened in 70 years.
In the Broadway play Hamilton, George Washington presses Alexander to winover more votes if he wants to implement his agenda.
“Winning was easy, young man. Governing is harder.”
Fed Funds Under Warsh
In the near term, no real change. Not just because of the voting composition, but because Warsh promised lower rates to land the job. I think he will advocate for lower rates this year.
He believes AI productivity coupled with a smaller Fed balance sheet allows for lower Fed Funds without stoking inflation.
Longer term, his focus on inflation could lead to rates not falling as much or increasing faster during the next cycle.
10 Year Treasury Under Warsh
Higher in general and a steeper yield curve. Potential liquidity issues could mean higher yields and leveraged positions must price in a reduced likelihood of a Fedput.
The market must have a longer memory than Trump. Long term yields and the dollar higher are signs the market reacted like he’s still a hawk cosplaying asa dove to get the job. Trump is likely a lame duck at year end and will be 93 years old when Warsh’s 14 year appointment to the Board of Governors ends. Does he revert to his hawkish tendencies once he’s less influenced by Trump’s attacks?
Final Thoughts
Maybe Warsh is what we need to extricate ourselves from the post-GFC cycle. If the economy and the financial system hold up while he reduces the balance sheet, we will probably look back at his term as successful.
My #1 concern is that he wasn’t persuaded by millions of Americans losing their jobs in the GFC.
O/U on how long before Trump is complaining about Warsh? Or launches a DOJ investigation?
A Note on Whether TillisCan Block Warsh Confirmation?
NC Senator Thom Tillis has said he will block any Fed nomination until the total bs fabricated DOJ investigation into Powell is resolved.
Tillis is a member on the Banking Committee, which oversees Fed nominations. The Committee votes on the nomination, and then the nomination moves to the Senate. But it’s not a majority vote, it’s just one of 3 recommendations: Recommended, Without Recommendation,Unfavorable.
That means once the vote happens, the nomination still moves forward even if every single Committee member votes “Unfavorable.”
The best way to prevent the broader Senate from voting is for the Committee Chair to simply never call for a vote. But the Chair is SC Senator Tim Scott who famously rolled over and said, “I love you” to Trump after conceding in 2024. He’s not going to withhold the vote.
How can Tillis actually blockWarsh’s nomination?
If Tim Scott calls for a Banking Committee vote on Warsh, there’s only one way it doesn’t move forward to the Senate for confirmation…
A tie.
Republicans have a 13-11 majority right now.
If Tillis votes against him, then we have a tie and the nomination gets held up.
I expect the DOJ investigation will suddenly wrap up in the coming weeks…