Q&A on Kevin Warsh

Warsh won't hike - he wants market to tighten for him instead

Thank you for subscribing to my posts. If you’re not yet a paying subscriber, please consider becoming one. That’ll allow you to DM me with questions and comments. I plan to move my posts behind a paywall in coming months. Subscribing now locks you in at a low rate. Thank you so much for your support and feedback!

Kevin Warsh did a great job in his first FOMC press conference. I was impressed by his poise and how he stuck adamantly to the two key points he wanted to make. The first was that he wasn’t going to provide any guidance whatsoever on the direction of monetary policy. That’s a big structural break for the Fed, which has been knee-deep in “forward guidance” ever since the 2008 crisis. The second was that he’s creating task forces to reexamine everything from communications to the size of the balance sheet and the inflation framework. Markets had a very hawkish reaction to all this, but I’m not sure that’s right. So today’s post is a Q&A on Kevin Warsh and Fed policy.

• Is Kevin Warsh hawkish? The new Fed chair was asked - over and over - whether he thinks the current stance of monetary policy is appropriate and whether hikes are necessary. He refused to answer any and all questions along these lines. Warsh believes the Fed should step back from all the hand-holding of markets it’s gotten dragged into over the past decade. The one thing he did reveal is that - in his view - the stance of policy looks uneven across the economy. Policy looks tight when you look at the housing market, but it looks too loose looking at the stock market. That sounds to me like someone who wants markets to tighten for him, i.e. push up market interest rates to bring stocks down. Markets immediately responded to this message. The black line in the chart above shows the midpoint of the 25 basis point range for the policy rate. The purple line shows the Fed’s projected path for this policy rate as of its Mar. ‘26 meeting, the red line is the same thing based on this week’s meeting and the orange line is what markets price as of now. Markets rushed to price more hikes, but I don’t think that gets Warsh the tightening he needs if he thinks stocks are too frothy. I’ll return to this below.

• Is the Fed going to hike or cut? By refusing to provide any forward guidance, Warsh is making us watch the data. If inflation cools, policy will ease. If it heats up, the Fed will hike. One of my core views is that the AI-productivity shock, by causing large-scale layoffs in the white-collar services sector, is deflationary, not inflationary, so my view remains that the next move for the Fed will be to cut. The chart above backs this up. It shows the combined weight of items in the CPI with month-over-month (black) and year-over-year (blue) inflation above two percent. I don’t see anything worrying in the more timely month-over-month metric, which is remarkable given the energy price shock of recent months. The Fed will end up cutting, not hiking.

• Will the “dot” plot get ditched? In my view, the “dot” plot is the worst form of central bank communication that exists. Some of my most stressful moments on the Goldman trading floor were trying to interpret this thing with traders yelling at me to know what’s up. If that’s hard for someone like me, this thing is going to be impenetrable for main street. Just ditch it and publish a fan chart like every other central bank. And - coincidentally - this isn’t about being a bad forecaster. The chart above shows the history of the Fed’s core PCE forecasts going back to 2012. I see no problem in the Fed getting forecasts wrong. The change from Mar. ‘26 to Jun. 26 is a good example. The severity of the war and resulting spike in oil prices were obviously impossible to predict. No shame in getting that wrong.

• What does this mean for financial markets? Warsh basically wants markets to tighten for him so that the stock market is less frothy. This reminds me of the “taper tantrum” in 2013, when then Chair Bernanke talked up long-term yields repeatedly, as the chart above shows. The thinking at the time was that this would tighten financial conditions, so the Fed wouldn’t actually have to hike. Warsh may have something similar in mind now, but there’s one complication, which is that - so far - the rise in rates is happening only at the short end of the yield curve (see chart below). That’s not enough to get stocks to fall. Markets are out of practice from the days of the “taper tantrum.” It’ll take a few more press conferences for markets to get the message. In the interim, this means more rate volatility and higher long-term yields as we transition to this new equilibrium.