Warsh Says Inflation Can Be Lower, Touts Reforms

A potential Warsh-led Fed signals a regime shift. Expect the death of forward guidance (dot plot) and a return to pure data dependency, increasing vol. The committee is seen as temperamentally hawkish, needing to lean against broadening inflation (services) and geopolitical price shocks (energy). With market yields already tightening financial conditions, the path of least resistance is a prolonged hold. The risk is skewed towards a hike, not a cut. Long USD, cautious duration.

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Federal Reserve 9.4
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Kevin Warsh 7.0

Warsh Says Inflation Can Be Lower, Touts Reforms

Mike

The President's statement that Kevin Warsh will be independent is not credible, but it gives Warsh runway to not cut rates due to inflation and the war. Warsh's plan may require raising rates, opposite of Trump's stated desire.
Stuart

Fed Governor Chris Waller supports making clear the next move could be an increase as likely as a cut. Traders are betting on a hike.
Stuart

There is a bet in the market for a hike, but I'm not convinced. Tightening financial conditions (2s and 5s up 75bps, 10s up 65bps) are doing the Fed's work, buying time for caution. The long end of the curve affects the real economy (home prices, mortgages, durable goods), and buying conditions are deteriorating.
Stuart

Warsh's key phrase is that the Fed must pursue its dual mandate with independence and resolve. This sounds hawkish. The world Warsh is moving into requires someone independent and temperamentally hawkish.
Mike

Warsh worked at the Fed for 5 years, giving him a better feel than a newcomer. Circumstances work in his favor: even if he wants to cut, 18 others on the FOMC vote. If they are on hold indefinitely, he doesn't have to push a consensus.
Mike

Warsh will likely say he doesn't like forward guidance, so they will be attentive to circumstances and vote at the time.
Stuart

Moving away from forward guidance is good for preserving optionality. It makes my job harder, but that's what I'm here to do. Warsh wants to move away from the dot plot and SEP.
Mike

The SEP is generally fine, but the problem is everyone looks to the median as a Fed forecast, when it's 19 different forecasts. Many FOMC members agree it's not the best way, but they need something until a better idea comes along.
Stuart

The SEP's real value was to indicate no intention to raise rates and flatten the curve. In a period of high inflation, uncertainty, and global shocks (pandemic, supply chain), the SEP constrains opportunity set and doesn't help communicate rates further out the curve. Warsh recognizes this and doesn't want to be backed into a corner.
Mike

The Fed does the SEP four times a year, but markets recalibrate four times a second. The narrative is always that the Fed is behind the curve. Even if officials want to change their forecast, it's harder to get across because people think they are constrained by the SEP.
Mike

The Fed's goal is stable prices, which may require raising rates. Inflation is going up. Warsh can do what Powell does: recognize the pain, but there isn't much the Fed can do to help people at this point.
Mike

Inflation has started to broaden out into service areas. Tariffs may mean we haven't seen the peak. The Iran war is driving headline numbers via energy prices. If the war ends, Warsh can say 'I can't cut today, but we're on a path to do it.'
Stuart

Warsh has said inflation is a choice central bankers make. With supply shocks and inflationary fiscal policy, the only control he has is to lean against demand, which he doesn't want to do. He wants more growth and higher real wage growth, so he needs to wait for inflation pressures to dissipate. It's a waiting game until low aggregate labor income and low real wage growth stifle the broadening of inflation.
Stuart

I don't think Warsh will be intimidated by Powell. Other folks on the committee are adequately independent and assertive. Enough folks on the committee are hawkish enough to prevent any missteps in the dovish direction.

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