Warsh, the hardliner

• Alexis Bienvenu
  Fund Manager
  La Financière de l’Échiquier (LFDE)

Speaking in a manner bordering on polite offence towards his predecessor Jerome Powell – who remains a member of the Board of Governors – he implicitly accused the Fed of failing to do enough to combat inflation for more than five years.

It is true that, since then, price rises have far exceeded the Fed’s official target of 2 per cent. Since June 2021, inflation has averaged 3.8 per cent^[1] and has never fallen below 2.6 per cent. Yet, “inflation is a choice,” the new chair asserted, true to his orthodox monetarist stance. The responsibility therefore lies with the Fed of the past. Everything must change. Everything will change.

First shift: the Fed will henceforth refrain from guiding the markets. Unlike the stance adopted since the 2008 crisis – when the predictability of monetary policy was valued by markets shaken by a crisis they had not anticipated – Warsh believes that the Fed must now draw on signals from the markets rather than the other way round. The direct consequence is that the central bank’s statement no longer sets out an implicit path for monetary policy, but is strictly limited to stating the facts.

The markets will have to draw their own conclusions: instead of systematically anticipating the Fed’s reaction to every piece of macroeconomic data, they will have to accept that they must wait for the Fed to speak out. In particular, the mantra ‘bad news is good news^[2] ’ could lose much of its relevance.

A second major shift: inflation will be the main focus of efforts, at the risk of relegating the other aspect of the Fed’s mandate – full employment – to the background; this was virtually ignored in the latest statement. Admittedly, with an unemployment rate of 4.3 per cent, there is no sense of urgency. But even when that rate was hovering around 10 per cent in 2010, Kevin Warsh was already standing out for taking a significantly less accommodative stance than his peers.

It was for this very reason that he left the Fed in 2011, disagreeing with the extension of asset purchase programmes. Having worked in close coordination with Ben Bernanke during the acute phase of the 2008 crisis, he judged that a further expansion of the balance sheet was not required, and chose to signal his opposition by stepping down.

This uncompromising stance now forms the backdrop to a third break with the past. Appointed by Donald Trump – who no doubt appreciated his criticism of the decisions made by Jerome Powell, who had become the president’s scapegoat – Warsh has no intention of simply continuing along the same path. He presents himself as a reformer, or even a dismantler of certain inherited practices, and is therefore launching five key initiatives: communication (an end to ‘forward guidance^[3] ’); the size and composition of the balance sheet, which he wishes to normalise; statistical tools deemed to be flawed; the analysis of employment and productivity dynamics in the age of artificial intelligence; and finally, and most importantly, the doctrinal framework for combating inflation, against a backdrop where a relaxation of the target had been mooted in recent years.

By appointing a maverick to head the Fed, Trump is turning the page on Powell. But he is also choosing a figure with strong convictions, equally keen to shake up the established order. In an environment where expectations of rate rises are growing, even as the White House would prefer monetary easing, the conditions for a possible clash are in place.

During Trump’s first term, the good rapport with the Fed lasted barely six months. With a Fed chair who is decidedly more uncompromising, how many days will the honeymoon period last?

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This information and these opinions are provided for information purposes only and, as such, do not constitute an offer to buy or sell any security, nor do they constitute investment advice or financial analysis. The opinions are those of the author; LFDE accepts no liability whatsoever in this regard. Past performance is not indicative of future results.

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^[1] ‘Core PCE’ index, source: Bloomberg

^[2] This expression implies that bad economic news – such as an economic slowdown – is good news for the markets, as the Fed is expected to adopt a more accommodative stance

^[3] ‘Forward guidance’, a communication practice used by central banks to provide information on their future monetary policy. In particular, on changes to their key interest rates.