New sheriff in town
The Kevin Warsh Fed is greeted with a dual-mandate dilemma.
Bottom Line
In an elaborate White House ceremony today, President Trump swore in Kevin Warsh as the seventeenth chair of the Federal Reserve. But the bond market and the remaining members of the Federal Reserve neglected to roll out the red carpet, as financial market conditions and monetary policy are somewhat inhospitable for the new leader.
Long and winding road It’s been a procedural struggle for Warsh to land the position. He is eminently qualified, having served on the Fed’s Board of Governors from 2006-2011, under Presidents Bush and Obama. But he was one of six candidates President Trump considered to replace former head Jerome Powell. In our view, Warsh got the nod, in part, because he was viewed as the most confirmable by the Senate.
That proved true as Warsh successfully navigated a contentious Senate Banking Committee hearing last month to reach the chamber floor, with a 13-11 party-line vote. The full Senate first confirmed him to a 14-year term as a Fed governor, replacing Stephen Miran. Then in a separate vote last week, the Senate voted 54-45 to confirm him to a four-year term as the chair. It was the narrowest confirmation in Senate history. Only Sen. John Fetterman (D-Pa.) crossed the aisle to join all Republicans, while Sen. Kirsten Gillibrand (D–N.Y.) abstained. This politicized result stemmed from concern about Trump’s assault on the Fed’s monetary policy independence.
A house divided Wednesday’s release of the minutes from the Federal Open Market Committee (FOMC) meeting last month sets a difficult table for the Warsh-led Fed. With four dissents, it was the most divisive meeting since October 1992. Also challenging is that Powell announced he will remain on the board following his terms as chair. The last time that happened was with Marriner Eccles in 1948. Powell can remain as a governor until January 2028. Lastly, three regional presidents (Beth Hammack, Cleveland; Lorie Logan, Dallas; and Neel Kashkari, Minneapolis) preferred removing the easing bias from the FOMC statement. Consequently, Warsh appears to have inherited one of the most divided Feds in history. We believe he would like to reduce interest rates, but that will be a struggle, especially if current economic conditions persist.
Phillips Curve tradeoff The Fed manages its dual-mandate goals of achieving maximum employment and stable inflation to make policy decisions. Those goals are in conflict at present:
- Labor market solid Nonfarm payrolls have grown by an average of 153,000 jobs in January, March and April; the unemployment rate has been stable at 4.3% in three of the last four months; and initial weekly jobless claims were only 209,000 for the May survey week. All of this suggests May’s payroll growth should be solid. There is no immediate need for the Fed to cut interest rates to support the labor market.
- Inflation rising due to Iran conflict Inflation had declined from 40-year highs in 2022 to five-year lows earlier this year. But the ongoing military conflict with Iran has thrown sand into the gears. What was expected to be a limited four-to-six-week engagement has now extended to 12 weeks and counting, with no end in sight. Crude oil (West Texas Intermediate, or WTI) and gas prices have soared by 50% to $97 per barrel and $4.55 per gallon, respectively. As a result, nominal CPI inflation has leapt from a nine-month low of 2.4% year-over-year in February 2026 to a three-year high of 3.8% in April. We expect the Fed to view this spike as temporary. We expect the Trump administration wants to resolve the conflict before the America250 celebration on July 4. Whenever it concludes, energy prices should fall sharply.
Bond market now expecting a hike The upper band of the fed funds rate is stuck at 3.75%. But two-year Treasury yields, at 3.4% when the Iran war started, have soared to 4.13% today. That suggests the bond market’s previous expectations of a quarter-point rate cut have flipped to anticipation of a quarter-point hike. Benchmark 10-year Treasurys, yielding 3.93% in late February, spiked to 4.69% earlier this week. As a result, there is no justification for an immediate rate cut, a reality we surmise Warsh, Trump and Treasury Secretary Scott Bessent understand. In fact, Trump mentioned the importance of Fed independence in his introduction of Warsh this morning.
To that point, at the Fed’s next policy-setting meeting on June 17, we believe Warsh will build support among his new colleagues by proposing to neutralize that “easing bias” language in the FOMC statement. That would demonstrate there is an equal chance of a hike as a cut at upcoming meetings and that the move would depend on the data, not political pressure.
A nod to Greenspan At his acceptance speech, Warsh invoked the memory of his predecessor Alan Greenspan. Much like Greenspan during the technology build-up in the 1990s, Warsh believes that the AI revolution today will boost productivity. US productivity has risen by an average of 3% over the past four quarters, up from a 2% average over the past 50 years. This increase should allow the Fed to reduce interest rates over time due to stronger economic growth, higher wages and lower inflation.
Balance sheet hawk Warsh would also like to shrink the Fed’s bloated $6.7 trillion balance sheet, likely starting with mortgage-backed securities. This could lower short-term interest rates but steepen the yield curve, reducing the Fed’s influence on the wealth effect, which has boosted the value of housing and equities.
Is the Fed’s 2% core PCE target the right objective? Warsh might direct the Fed’s many economists to study that long-standing belief. He has mentioned his preference for the trimmed mean, an inflation measure that removes the most extreme price changes across a broad set of goods and services. Unlike the core PCE, which excludes volatile categories like food and energy, the trimmed mean focuses on the central tendency of price changes.
Honeymoon now, correction later? Over the past 93 years, there have been 11 leadership changes at the Federal Reserve. In every instance, the S&P 500 greeted the new Chair with a honeymoon rally for a few months followed by a moderate correction of about 10% as investors questioned the new leader’s chops. Each time, the market found a bottom, and stocks rallied to record highs by year-end.
The next FOMC meetings end June 17, July 29 and September 16. Warsh will deliver his first keynote speech at the Fed’s annual Jackson Hole, Wyo., central bank symposium August 28. So, there will be ample opportunity in coming months for the markets to evaluate his plans.
Read more about our views and positioning at Capital Markets.