A long-standing critic of the Fed, incoming Chairman Kevin Warsh is set on bringing in a new era for the Federal Reserve. Though the institution’s consensus-driven nature will likely prevent a large shift in its overall monetary policy reaction function, Chairman Warsh is most likely to also bring about changes that could result in a smaller balance sheet, looser bank regulations, and an overhaul of the way it communicates with markets.
Having cleared the political logjam in the Senate Banking Committee, Kevin Warsh is all but expected to be confirmed by the full Senate and seated at the Federal Reserve by May 16. While this removes a key unknown facing the Fed, another important consideration is Powell’s historically rare decision to remain as a Fed Governor after his term as Chair ends. Though Powell has stressed that he will take a more backseat role from a public perspective, his choice to stay—potentially through to the end of his term in 2028—could still allow him to exert his influence over policy decisions and provide a counterweight to Warsh. Importantly, it also limits President Trump’s ability to reshape the Committee with additional appointments more aligned with his preferences. This shuts the door, for now, on his ability to further solidify his influence over the institution. With ongoing concerns about the Fed's independence, Powell’s decision to stay on will not only add uncertainty to the impending leadership transition but also potentially complicate the Warsh Fed’s reaction function.
Though Warsh often had a hawkish bias during his time as a Fed governor from 2006 to 2011, especially after the global financial crisis, his remarks more recently have leaned in the opposite direction.
He has argued that the U.S. economy faces an enduring AI-driven productivity boom that will lead to significant disinflationary pressures. Indeed, given what’s at stake, this is an area in which Chair Warsh is likely to push Fed staffers to produce more research to inform policy direction. He’s also doubtful of current measures of inflation, preferring instead trimmed mean or median measures—both of which are running below headline or core PCE inflation.
Trimmed mean inflation measures are alternative gauges of underlying inflation that remove the most extreme price movements in each period. By trimming unusually large increases and decreases, these measures aim to filter out temporary and potentially idiosyncratic inflation volatility.
Though Warsh has argued that these measures produce better signals of broad-based inflation trends than headline and core inflation, markets have generally pushed back on this view as they failed to capture the build-up in the most recent post-pandemic surge in inflation. Taken together, these demonstrate that Warsh is less concerned about the inflation picture today. Moreover, his preference for looking through one-off price spikes driven by tariffs, conflicts, or supply disruptions, supports at least another rate cut later this year.
Even under a new chair, the Fed’s consensus-driven framework should act as a check on any sharp shift in monetary policy.
This puts Warsh on the dovish end of the spectrum, but his views do come with some skepticism. Coincidentally or not, combined with the Trump administration’s clear preference for lower interest rates—and the perception that Warsh was selected to potentially follow through on these demands—it could add to concerns around Fed independence. Price stability has not yet been fully achieved, and with energy prices surging, there is a risk that an inflationary impulse is brewing, which would be amplified by a policy mistake.
However, the Fed's consensus-driven framework should serve as a crucial check. A majority of the 12-member Federal Open Market Committee (FOMC) is required for monetary policy decisions. Warsh will be but one vote among many and thus will need to be convincing enough to move policy one way or another. These dynamics ensure that decisions are discussed thoroughly. While Fed Chairs do tend to carry a lot of weight in setting policy, there have been several instances in the past of the “committee view” overriding the Chair altogether.
Warsh has been a long-time critic of the Fed, so his chairmanship is likely to bring several structural changes to the institution. Among them, and perhaps one that will have the largest impact, is around the Fed Balance Sheet.
Having opposed the ongoing use of Quantitative Easing in the aftermath of the financial crisis, arguing that it distorted financial asset prices and contributed to broad economic inequality, the Warsh Fed is likely to lean toward interest rates as the primary tool for conducting monetary policy.
To this end, shrinking the $6.7 trillion Fed balance sheet will be a key priority, though this process is unlikely to be entirely frictionless and will entail its own risks. A move to actively sell its Treasuries holdings could lead to tighter financial conditions and hurt market liquidity. It would also push longer-term interest rates higher and add pressure to asset risk premiums.
Market stress could be minimized, however, if this comes on the back of a looser regulatory regime. Changes to capital rules, together with updated guidance on liquidity requirements, would give banks greater flexibility in managing their reserves, enabling them to absorb excess Treasury supply from the Fed. The broader move to ease financial regulation, particularly for small and medium-sized banks, could lead to increased capital deployment, and improve overall credit availability and bank profitability. Though much of this will require coordination with other agencies, Vice Chair for Supervision Michelle Bowman, who was sworn in last November, has already moved swiftly to lay the groundwork and has proposed recalibrating unfavorable Basel III capital regulations.
Finally, Warsh will thoroughly question the Fed’s communication framework, arguing for a “less is more” approach. He has expressed skepticism about the FOMC’s summary of economic projections (the so-called “dot plot”) and has called for fewer policy speeches and press conferences.
However, any material changes would face high hurdles. Outgoing Chair Powell himself noted that he “was never the world’s biggest fan of the dot plot,” but a lack of agreement on a better replacement ultimately hindered any changes. This highlights that changes to the Fed’s collective communication process cannot be made unilaterally and will require consensus among the FOMC. Moreover, when it comes to individual communications by Fed Governors and Bank Presidents, Warsh’s power is even more limited in practice.
Nevertheless, much like previous Chairs, it would not be surprising to see Warsh conduct a broad review of the Fed’s forward guidance. Indeed, Warsh has argued that it limits the Fed’s flexibility, essentially locking it into a specific policy path that may no longer be warranted if conditions shift in the future. However, absent regular communication or official projections, markets have nothing to anchor themselves to, which can drive greater interest rate and market volatility.
A semblance of clarity has finally been introduced with the imminent appointment of Kevin Warsh as the new Fed Chair, though this is muddied by outgoing Chair Powell's unexpected decision to stay on as a member of the Fed’s Board of Governors. Warsh’s reaction function is likely to skew dovish, though this should be tempered by the Fed's consensus-driven framework. Nevertheless, it supports our view that at least one more 25 bp cut is likely before the end of the year. Against a backdrop of hawkish global central banks, this will likely lead to further dollar weakness.
Chair Warsh also brings a reformist agenda focused on shrinking the Fed’s balance sheet and questioning the way it conducts forward guidance. Yet, at the same time, the move toward a looser financial regulatory environment should provide a critical offset, leading to improved overall credit availability and bank profitability. Over time, these forces would have a multifaceted impact on the yield curve. At the front-end, a dovish reaction function would put downward pressure on interest rates. Simultaneously, the long-end of the curve should move higher amid a smaller balance sheet, while reduced forward guidance should lead to higher risk premiums and market volatility. These dynamics, taken together, should steepen the curve.
Ultimately, the appointment of Kevin Warsh as Fed Chair marks the beginning of a pivotal era for U.S. monetary policy. With structural shifts and ongoing shocks shaping the economic landscape, the Fed's evolution is another development for investors to monitor. As much as ever, staying alert to policy signals and market responses will be essential for navigating the evolving macro environment and seizing new opportunities ahead.
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