Warsh's Regime Change
Doug Nolan
He was impressive.
Listening intently to Kevin Warsh’s post-meeting press conference was a reminder of why I admired Fed Governor Warsh (2006 to 2011) and was disappointed to see him leave the institution.
The new Chair conveyed complete control over the subject matter, as well as admirable commitment and determination to uphold the great responsibility of leading our central bank in an uncertain and unstable era.
It was only 45 minutes, but his opening Chair performance outshone all predecessors back to Paul Volcker.
Warsh:
“We recognize that inflation has been running well ahead of the Fed’s long-stated inflation goal of 2%.
That’s been going on for more than 5 years.
Persistently high prices are a burden for the American people.
But the recent past need not be prologue.
I am pleased to report that members of the FOMC are unambiguous and unanimous:
This Committee will deliver price stability.”
“…We have the capability and commitment to deliver on our price stability objective of 2%.
That’s exactly what we’re going to do.
In the Fed’s review of its strategy over the last any number of years, in January, the Fed -- including the strategy that we’re still bound by – the Fed statement says that inflation is primarily determined by monetary policy.
You bet it is.
I’ve said for years inflation is a choice.
You bet it is.
And today I’m announcing that this committee unambiguously and unanimously have decided we are going to deliver on that.”
“Inflation remains elevated relative to the committee’s 2% goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy.
The paragraph goes on to say, but, to be clear, the Fed will deliver price stability.
My own judgment is the committee spent quite a bit of time, not just in two days, but over iterations of a couple of weeks.
That’s what we’re prepared to say about inflation.
But the commitment to deliver is strong, unanimous, and unambiguous.
And that’s, I think, an important message we’ve missed for five years, and we’re going to fix that.”
“Today I think we had something important to say about our commitment to deliver on price stability, our commitment to rethink practices with an eye of moving the Fed forward, and to give you and the American people a sense that these aren’t idle thoughts, these are concrete thoughts, that we’re going to seek out the best minds -- both the best thinking inside of the Federal Reserve and the best people I know in business and economics and the academy and technology, and the rest -- to share their views.
That’s what we’re going to be doing here, the pursuit of truth.
I think we’re going to come up with some new and interesting things.”
June 17 – Bloomberg (Maya Prakash):
“Federal Reserve Chairman Kevin Warsh’s highly anticipated maiden press conference… was, according to many Fed watchers, smooth, polished and tightly controlled…
Economists largely gave Warsh high marks on style, saying he avoided major missteps and communicated his priorities clearly.
Some, however, noted he sidestepped tougher questions on topics such as how, exactly, he would lower inflation.
‘It was classic Warsh.
His comments were slick and well-rehearsed,’ said Joe Brusuelas, Chief Economist, RSM US.
‘One of the hallmarks of Warsh’s style that he has developed over the past three decades is that of a policymaker with strong preferences that lean in the direction of market-based indicators and preferences, rather than the more intellectually nimble framework favored by Ben Bernanke and Janet Yellen.’”
“Slick and well-rehearsed” – but not in a negative way.
The backdrop demands a price stability hyper-focus.
The new Chair delivered the appropriate message loud and unmistakably.
Coincidentally, a few hours after Warsh’s press conference, President Trump signed the U.S.-Iran memorandum of understanding (MOU) as he dined with President Macron at the Palace of Versailles.
For Warsh’s inflation focus and Trump’s MOU, both provided encouraging starts.
Really tough challenges await.
Success, on both fronts, hangs in the balance.
Colby Smith from the New York Times:
“…I am curious how restrictive you think things are at the current moment, given the flow of data that we've seen, and you know, forecasts that are coming down the pipeline.”
Warsh:
“I’ve heard characterizations both inside and the Fed about that.
I’ll give you my own.
It’s uneven.
If I look at the housing markets as one example, Fed policy isn’t the single determinant of the state of the housing market.
But broadly, I would say Fed policy appears to be somewhat restrictive.
I would have a hard time managing to say those words if I were to see what’s happening in financial markets.
So, I’d say it’s uneven.
That’s perhaps a function of different transmission mechanisms of monetary policy, whether monetary policy is coming from our interest rate tool or our balance sheet tool.”
“Uneven” perhaps, but from a systemic standpoint, the somewhat restrictive policy stance from the housing perspective is inconsequential compared to loose conditions virtually everywhere else.
Importantly, Warsh specifically noted the unrestrictiveness of “what’s happening in financial markets.”
It’s the booming financial sphere that today poses the greatest risk to monetary and price stability.
I would have welcomed even terse mentions of some critical issues.
“Financial conditions,” “Credit,” “hedge funds,” “leverage,” and “Wall Street” went unspoken.
But the Chair’s comment regarding “what’s happening in financial markets” was a subtle shot across the bow.
June 19 – Reuters (Howard Schneider):
“U.S. Federal Reserve Chairman Kevin Warsh put his stamp on the job fast this week at a debut policy meeting that produced a return to stripped-down, 1990s-style central banking, before this century’s crises put the Fed center-stage in economic management and turned its leader into a consoler-in-chief for Wall Street and Main Street alike.
The question now is whether the reduced role he seeks for the Fed and in effect for himself is compatible with a world grown more complex, a more-intense and polarized information environment, and markets now accustomed to a steady diet of top policymaker commentary.”
Howard Schneider’s above article included insight from (former top NY Fed official) Evercore ISI’s Krishna Guha:
“The market reaction ‘was massively amplified by the Warsh press conference that combined a hawkish near single-mandate emphasis on the need to deliver price stability, with a total absence of any modulating discussion of the Fed’s strategy or reaction function.
Discussion of the reaction function and strategy... supports more effective central banking,’ a main tenet of current central bank practice.”
A Thursday Bloomberg article (Greg Ritchie, Ye Xie and Michael MacKenzie) quoted Johnathan Owen, portfolio manager at TwentyFour Asset Management:
“He said absolutely nothing about the future of Fed policy, which leaves the markets in the dark.
If it is a Fed that’s going to rely on a lot more real-time data, that’s how markets will trade.”
Tim Mahedy, chief economist at Access/Macro (PRNewswire):
“We’re going to be parsing through comments trying to figure out what the reaction function is.
It’s just like 1995 again.”
New Century Advisors’ Claudia Sahm:
“I still have no idea what Kevin Warsh thinks about monetary policy.
Maybe we need a task force for that!
Saying you will deliver on price stability without explaining how you might do it is empty words.”
Warsh:
“Financial market prices are probably the most important source of information to guide central bankers.
But when all the financial markets are doing is reflecting back what we’ve said, then we’re taking the most important source of information, and we’re being blind to it.”
Kevin Warsh is approaching “regime change” with purpose.
His term will undoubtedly be of major historical relevance.
There were some less consequential changes to get the ball rolling: an abridged Fed policy statement and somewhat abbreviated press conference; a “dotless” Chair and, more substantially, a moratorium on forward guidance.
A herd (five) of task forces will be engaged for a comprehensive review of communications, the Fed’s balance sheet, data/information sources, productivity and employment, and the Federal Reserve’s inflation framework.
Regime change is certainly overdue.
I’ll go so far as to say Warsh is “the right guy.”
It’s the “right time” issue where problems await.
“Regime change” would be a predictable post-Bubble development.
But we’re operating in Peak Bubble.
Federal Reserve institutional transformation and inflation containment – with vulnerable Bubbles not missing a beat?
“Everybody has a plan until they get punched in the mouth.”
Two-year Treasury yields surged 13 bps in post-press conference Wednesday trading – the largest jump since (“liberation day” turmoil) April 9th, 2025.
At Thursday’s close, the market was pricing 93% probability for a (25bps) hike by the September 16th meeting (39% for the July 29th gathering).
The market is now pricing two hikes over the next nine months – versus almost three (2.78) cuts back on pre-war February 27th.
Markets took Chair Warsh’s regime change introduction party pretty well, considering the hawkish tenor and the cold-turkey withdrawal of coddling and handholding.
The Semiconductor rocket ship managed only a 1.4% gain during the session, as the S&P500 declined 1.2%.
In a different environment, markets might have buckled.
After all, Warsh is committing to getting inflation back to target after five years of Fed flailing.
It was a risky gamble when the Fed moved to slash rates in September 2024.
If premature loosening accommodated upward pricing pressures, the next round of rate hikes would only confront more deeply entrenched inflationary dynamics.
That’s today’s predicament.
Conditions have been extraordinarily loose, debt growth has accelerated, monetary inflation has gone into overdrive, and manic market excess has been nothing short of historic.
In short, protracted “terminal phase Bubble excess” has gone to unprecedented extremes.
At this point, I believe a true tightening of financial conditions will be necessary to contain inflationary forces.
It will require slower Credit expansion and a tighter liquidity backdrop.
Tightened conditions would be perilous for historic Bubbles, at home and abroad.
Markets are pricing a 4.03% policy rate at yearend – with a 4.14% peak rate at the March 2027 FOMC meeting.
With the current trajectory of excess, including debt growth, market speculation and AI arms race spending, a 4% policy rate will be insufficient to wrestle stubborn inflation back to target.
“If it can’t happen, it won’t happen.”
Markets listened to Chair Warsh talk the talk, while completely dismissing the possibility that the Fed might actually move to tighten financial conditions.
After all, rates that were hiked to (5.25% to) 5.5% (pre-9/18/24 loosening) failed to tighten conditions.
A serious effort to rein in today’s deeply entrenched inflation would contemplate the possibility of meaningfully higher policy rates – perhaps even to 6 or 7%.
Markets enjoy unwavering confidence that the Fed would not dare contemplate such a policy approach that would risk bursting Bubbles.
Fox Business’s Edward Lawrence:
“So, if you don’t give a lot of ongoing forward guidance, won’t the markets have more volatility?
And shouldn’t Americans have more access into what you’re thinking going forward?”
Warsh:
“So, I think financial markets perform best when they react to incoming data.
I think the financial markets work less efficiently when they ask a question: How will the Federal Reserve react to that incoming information?
The more that markets are paying attention to what’s happening in the real economy, deciding what’s good data and what’s less-good data, the more financial markets can price what they believe is the most likely and what are the tail risks.
Financial market prices are probably the most important source of information to guide central bankers.
But when all the financial markets are doing is reflecting back what we’ve said, then we’re taking the most important source of information and we’re being blind to it.
I’d like us to create a system where those blinders come off, where markets are following data that they efficiently think is reliable, and they’ll be watching data, we’ll be watching data, they’ll come with better information through market prices to us.
We can make more-informed decisions with, ultimately, the goal that I set at the outset: Deliver on the price stability objective that Congress told us to do and that we’ve got to get in the business of doing.”
Kevin Warsh is right on this.
Wall Street and the Federal Reserve have been locked in a dysfunctional co-dependent relationship.
A central bank should avoid pre-committing to a future policy course.
The Statement of Economic Projections (more specifically with projected policy rate “dots”) encourages markets to speculate on prospective policy moves, which then biases future decision-making.
The FOMC needs to be nimble and not face pressure from shifting forecasts and upsetting the markets.
When Fed officials publicly and in detail convey their views, there is a psychological component of seeking to avoid criticism from “flip flopping” and misjudgments.
This is an especially powerful late-cycle dynamic.
Markets ignore myriad risks, including troubling inflation dynamics, confident that the Fed will not risk bursting Bubbles.
Markets price ongoing relatively low policy rates and loose conditions, content to disregard Credit excess, asset Bubbles, and overheating risks.
Faith in the Fed’s liquidity backstop ensures markets price “the most likely” while almost completely disregarding “what are the tail risks.”
Hyman Minsky’s “stability is destabilizing” theory is apt.
Believing the Fed is trapped by systemic Bubble fragilities, the market prices ongoing low rates and monetary policy accommodation – irrespective of economic, financial, and market developments.
Such a backdrop only fuels self-reinforcing Bubble excess.
Importantly, the markets’ pricing of policy stability breeds the kind of behavior (i.e., speculation and leverage) that exacerbates system fragility.
This ensures that the longer things remain ostensibly stable, the more precarious the underlying backdrop becomes.
Bloomberg’s Enda Curran:
“Could you guide us through, please, some of the principles that guide your own reaction function, and tell us a little bit about the kind of conditions that you think when the Fed should respond?”
Warsh:
“It’s going to be a very unsatisfactory answer to the final question.
The Federal Reserve has a lot of responsibilities -- not just in monetary policy, but in supervision and regulation, consumer affairs, and payments.
My own view is our credibility comes from delivering on what we’re saying we’re going to do across everything we do.
I’ve devoted more time in my first three weeks to monetary policy than all those things.
But the more we deliver on our promises as good supervisors and good regulators, the more benefit we get, the more credibility enhancement we have in monetary policy.
When we deliver on our price stability objectives - which we will - the American people will feel as though the hardships that they’ve been living through in part because of inflation in the last five years are in the rear-view mirror, and that credibility will have dividends across what we do.
And the institution will come to press conferences like this always with an impetus to reform, always with an impetus to do better, but we’re going to put some points on the board.”
“Unsatisfactory” indeed.
Not sure how long the Chair can dodge the “reaction function” question.
Surely, Warsh has well-defined thoughts on this critical issue.
He has had three decades to shape his analytical framework, including the past 15 years working with Stanley Druckenmiller.
Perhaps his strategy is to afford his task forces the opportunity to do their work and come with comprehensive analysis and recommendations.
Until then, for better or worse, key elements of the new regime’s policy analytical framework will remain somewhat of a mystery.
If I were a task force member, I’d be an impassioned proponent of incorporating financial conditions analysis as a fundamental policy analytical focus.
Scrap problematic “neutral rate” conjecture.
Focus instead on lending conditions, the marketplace liquidity backdrop, debt issuance and Credit growth, speculation and speculative leverage, Wall Street risk intermediation, risk premiums and financial flow analysis.
It's difficult to believe that Mr. Warsh’s 15 years alongside Stanley Druckenmiller haven’t been transformational.
For a Fed official, let along the Chair, he has gained unique insight and perspective.
I’m assuming he understands the issues, the “plumbing,” the excesses, the vulnerabilities, and most things contemporary levered speculative finance.
Warsh has intimate knowledge and understanding of today’s Bubble.
He’s been in the catbird’s seat, watching, thinking, discussing – and contemplating possible policy prescriptions.
This could go either way.
The Warsh Fed might orchestrate a tightening, with a focus on containing both inflation and precarious financial excess.
That would be a perilous course, which future historians might find parallels to Paul Volcker.
More likely, Warsh will attempt to thread the needle between moderate containment of inflation and financial excess, while avoiding Bubble piercing.
We can imagine, over French toast and strawberry waffles, Warsh and Bessent discuss weekly the perils of bursting Bubbles and the absence of good policy options.
Resolved to avert catastrophe, growing out of over indebtedness and imbalances might be viewed as a gamble worth taking.
They should know better.
There will be no growing out of the consequences of history’s greatest Bubble.
Warsh:
“If I heard one other thing around that subject over the course of the last couple of days, what I heard was that strong productivity-led growth is not something that we fear but something we embrace.
Thank you all very much.”
Warsh’s Regime Change is a momentous development at a perilous juncture.
The entire architecture of global financial asset prices rests on the assumption of indefinitely loose monetary conditions.
Unprecedented speculative leverage has accumulated on the presumption that the Federal Reserve and global central bank community guarantee unrelenting low rates and liquidity abundance.
Is market adjustment in the offing?
At the minimum, Kevin Warsh has injected major additional uncertainty into an already complicated equation.
The Dollar Index rose 1.0% this week to a one-year high.
Currency markets, curiously stable throughout the war, appear at the cusp of instability.
Nervousness must be building throughout the levered EM “carry trade” universe.
And while the AI mania/arms race remains in full force, festering de-risking/deleveraging risks are evident elsewhere (i.e., bonds, crypto, commodities, metals…).
With the war MOU, the SpaceX IPO, and quarterly options/derivatives expiration all now behind us, an abrupt change in the market environment is not an unlikely scenario.
Warsh:
“But our number-one goal is to get monetary policy right.
The way to get monetary policy right is to deliver on the remit that Congress gave us, to deliver on price stability.”
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