The Fed Is Close to a New Head

Fed head nominee Kevin Warsh is finally rounding third base, with confirmation hearings done and the path to a Senate vote cleared. This means two things for investors: Uncertainty is falling (yay), and we can all get back to the regularly scheduled business of watching the Fed deliberate verrrrrry sloooooowly. Dialing down the temperature is no bad thing for markets.

When last we checked in with this saga, Warsh’s nomination was in limbo. Not because many Senators had beef with his appointment, but because the Justice Department’s criminal investigation of Fed head Jerome Powell lingered. As long as it did, the Republicans on the Senate Banking Committee didn’t have the votes to move Warsh along to the full chamber. But last Friday, the Justice Department dropped its investigation. And after last week’s confirmation hearings, where Warsh followed the standard playbook (dodge, obfuscate, refuse to commit to a policy path, make some awkward jokes), the committee vote is scheduled. If all stays on course from here, this week’s Fed meeting will be Powell’s last one in the hot seat, with Warsh taking the gavel next month. In short, several of this year’s Fed unknowns are becoming knowns.

Soon we should get clarity on some other related items. Powell initially pledged to stay in his Fed board seat (which terms out in 2028) at least until the criminal probe was truly done and dusted. While the Justice Department formally dropped it, it “kept open the possibility of restarting at any point,” if the Fed’s inspector general uncovers issues.^[i] Backroom assurances from federal prosecutors were enough to get the Senate vote moving, but will Powell see it that way? If so, will he choose now to bow out, or will he have some fun and stay on? We doubt it matters a ton either way, given his is but one vote on the 12-member Federal Open Market Committee (FOMC), but markets like having one less question. Stay tuned.

Aside from this, personnel questions are mostly done. Stephen I. Miran will also be out after this meeting, as Warsh will be taking the seat he vacates in May. Effectively, it replaces one of President Donald Trump’s appointees with another, one gentleman who voted for rate cuts with another gentleman people think will vote for rate cuts.

To that, we say, hold your horses. No one, not even the FOMC folks themselves, knows how they will vote at mid-June’s meeting, which will be Warsh’s first. Despite some Senators dubbing Warsh a Trump “sock puppet” during the hearings, he confirmed he didn’t pre-promise monetary policy to win the job. Meanwhile, the other continuing FOMC member who once voted for rate cuts and sought Trump’s nomination for chair, Christopher J. Waller, has changed his tune lately. White House folks who previously lobbied for rate cuts, including Treasury Secretary Scott Bessent, now advocate wait-and-see.^[ii] Also, the meeting is a month and a half away, and all Fed decisions are data-dependent. We don’t know what incoming data will look like, nor how everyone will interpret it, nor how Warsh will mysteriously change from whatever views he espoused before taking over (as Fed heads famously do).

More interesting to us are the more procedural and boring things involved. Earlier this year, the Fed proposed reducing banks’ capital requirements to free up more funding for lending and pull some financing activity back from private credit to traditional banks. How will that effort evolve under Warsh? What about other deregulatory efforts, which have stalled a bit amid gridlock on the Fed’s governing board, as The Washington Post explored Tuesday?^[iii] How will Warsh pursue his desire to abolish the Fed’s (in our opinion useless) dot-plot forecast of future policy rates, hold fewer press conferences and make the Fed boring again? (Yes and amen!) And most importantly: What will he wear at Jackson Hole this August?^[iv]

The other interesting action item: Potential reduction of the Fed’s balance sheet. Warsh has also advocated this, arguing Fed ownership of US Treasurys blurs fiscal and monetary policy. He served at the Fed 20 years ago, when the Fed’s balance sheet was slim and policymakers managed interbank liquidity with short-term Treasury purchases. What will a Warsh-led Fed believe the optimal balance sheet size is? How will they elect to get there? And how quickly will they move?

Of all the things on the Fed’s docket, this one has the sneaky potential to be most consequential. Fed monetary policy doesn’t work if reserves get too low, for technical reasons we won’t bore you with, and policymakers resurrected the old short-term Treasury tool in December. Will this work well enough to allow further balance sheet runoff? If so, how quickly the Fed moves is key. Warsh has said letting the balance sheet shrink would enable more rate cuts, on the theory that rising long yields would be “tightening” to offset the “loosening” of rate cuts. But this scenario could widen the yield curve in a hurry, risking overheating. That isn’t a near-term thing, but it is a potential monetary policy error getting little to no attention.

Most likely, based on everything we have seen: These cats move slowly and deliberately, forming committees and building consensus. There will probably be studies. Working groups to discuss the studies. Long meetings whose transcripts will bore us five years after the fact. This potentially creates time for markets to digest pending changes gradually, sapping surprise power. That doesn’t negate the risk of monetary error, but it probably eases the risk of sudden structural or regulatory change catching markets off guard.

So follow along if you like, and we will be here to parse it for you and cover the latest.