Chairman Kevin Warsh is moving fast on the Federal Reserve’s public face, but the institution’s real power still bends around inflation, market pressure and the limits of its own hierarchy. He has shortened the news conference after meetings of the Fed’s rate-setting Federal Open Market Committee and changed the seating arrangements for reporters to be alphabetical by news organization. Small gestures. The machinery stays the same.
Who Has the Power
Warsh has not yet acted on one of his key priorities, cutting the Fed’s balance sheet, in part because inflation is a more pressing concern. He has also boxed himself in by appointing five task forces to examine Fed practices, with reports due early next year. That means the central bank’s top brass is still waiting on its own internal committees while prices keep grinding upward and the rest of the economy takes the hit.
Last week’s unanimous quarter-point interest rate increase, and any that follow, will likely be the highlights of Warsh’s early tenure, answering critics who questioned his independence from President Donald Trump. The increase was the first since 2023. Warsh appears likely to support additional hikes if inflation remains a problem. The people who borrow, pay mortgages, or carry consumer debt don’t get a vote in that setup. They get the bill.
Wall Street is sending a strong signal of its own. The 2-year Treasury yield traded nearly a full percentage point above the effective federal funds rate on Wednesday, the largest spread of the 2-year over the funds rate since 2023. Inflation was running at 3.7% as measured by the Fed’s preferred personal consumption expenditures indicator in July, the most recent reading, and it has been above the central bank’s 2% target for more than 5½ years. That’s the reality the Fed keeps managing from above.
At his Sept. 16 news conference, Warsh dismissed the idea of describing the funds rate as accommodative, neutral or restrictive, saying the concept is “useful academically” but had no bearing on the decision to hike. The comments caused consternation among some in the central banking world. Economist Claudia Sahm wrote, “What is odd is that Warsh framed the decision as 'removing a dose of accommodation' and then distanced himself from the concept that defines accommodation,'' and asked, “But now that the Fed has hiked, how will he judge whether to hike again, and when to stop?”
What They're Calling 'Order'
Warsh’s critics argued after his vague performance in July that he lacked credibility because he hadn’t articulated a consistent theory for how to set interest rates. A careful look at his public comments suggests a new regime for determining policy is being gradually articulated. That regime includes a broad array of financial and market indicators. Three times in his Jackson Hole, Wyoming, speech and three more times in his most recent news conference, Warsh highlighted “financial conditions” as a key to his thinking. He said a review of market conditions indicated to him that conditions were not restrictive.
He pointed in Jackson Hole to “the level and change in asset prices across sectors ... the prices and trading volumes of Treasury securities ... the foreign exchange value of the dollar ... the cost and availability of credit ... and the price of a broad set of commodities.” Warsh said, “These and other indicators should inform the Fed’s near-term outlook on economic activity and inflation throughout the business cycle. They should also reveal the state of broader financial conditions ... and the risks and uncertainties in the financial cycle.''
The article says that logic may strike some as circular, since expectations for the Fed form a large part of financial conditions. But taken at face value, the comments indicate scope for further hikes. The stock market remains buoyant, the labor market is robust, most financial conditions indicators continue to show little restraint, and growth looks strong. The market is sending the same message with the probability of a follow-on hike in October at 70%, and as many as two more priced in from now until March.
Warsh’s focus on sometimes arcane market indicators is more intense than previous chairs and somewhat reminiscent of former Fed Chair Alan Greenspan. In his Jackson Hole speech, Warsh said he was watching a suite of indicators for monetary expansion including credit spreads, the Fed’s Senior Loan Officer Opinion Survey, which gauges the willingness of banks to lend, and credit availability and demand. His conclusion: money is easy.
“That helps explain the growth we’ve seen this year in those loans,” he said. “Credit and loan markets are showing few signs of policy restraint.” He also said, “We should pay attention to money created by the central bank and money that comes from the banking and financial systems.” The article says continuing loose credit conditions clear the way for further rate increases in Warsh’s framework, but hikes will be likely only if inflation remains high along with oil and diesel prices.
Warsh also said at Jackson Hole, “The recent rise in overall commodity prices also bears watching.” The Bloomberg Commodity Index is up more than 30% this year, and some energy products are faring worse: diesel has risen 83%.
The Slow Grind of Reform
It’s unclear whether other members of the FOMC have cast off the neutral framework and adopted one more closely aligned with Warsh’s broad concept of financial conditions. Former Fed Chair Jerome Powell often noted how difficult it was to determine the neutral rate, but still often described rates as “modestly restrictive.” So far, Warsh has been virtually alone in refusing to forecast the outlook for the funds rate in the Summary of Economic Projections, the so-called dot plot. Many board members also continue to offer their outlooks for the economy and rates in speeches and interviews, a practice Warsh has rejected. That reluctance highlights the slower parts of regime change so far.
Reform has arguably been slowest on Warsh’s longest-standing policy priority. Since at least 2011, Warsh said the Fed should reverse the growth in its balance sheet, now at $6.7 trillion. He hasn’t committed to a plan for making that happen, which could mean selling securities the Fed already owns or allowing bonds to mature without replacing them. He quit his first stint on the Fed’s board in 2011 because he was uncomfortable with the growth in the balance sheet, though he said he voted for expanding it out of loyalty to the institution.
Back in control of the Fed’s agenda, Warsh still can’t quickly follow through on his plans for balance sheet cuts, even though that could in theory have taken more accommodation out of the economy. The FOMC’s minutes for July show other voters were reluctant to move quickly toward cutting the balance sheet, preferring to wait for Warsh’s task forces to report back. The state of the economy and the markets also may have complicated his plans. With inflation above the Fed’s target and oil surging, the committee had an immediate need to address prices, making it the wrong time to experiment with whether Warsh was right that cutting the balance sheet would meaningfully restrain the economy.
Meanwhile, the yield on the 10-year Treasury has risen above 5%, pulling up rates on mortgages and other consumer debt with it. That makes this a particularly inopportune time for the Fed to start asking the market to take on additional supply of mortgages and Treasury notes if the Fed were to reduce the balance sheet. The people at the bottom keep absorbing the shock while the central bank debates its own language, its own indicators and its own pace.