A blurry Warsh era at the Fed

With Kevin Warsh now officially appointed as the new Federal Reserve (Fed) chair, all eyes will be on him at the next Federal Open Market Committee meeting, scheduled between June 16 and June 17.

While the market has not priced in any rate moves, the language used by the committee, if any, will cement Warsh’s tenure as Fed chair over the next few months or even years.

In the run-up to his candidacy as well as interviews with the Senate Banking Committee, Warsh has been hinting at what his appointment as the new Fed chair would mean.

He had commented on key issues, including interest rates, the size of the Fed’s balance sheet, the institution’s independence, inflation, as well as issues related to the Fed’s communication strategies concerning the market.

Shrinking balance sheet

The Fed’s balance sheet was last seen at about US$6.7 trillion, a quarter less than its peak of almost US$9 trillion post Covid-19 in April 2022.

While the Fed has successfully reduced the size of its balance sheet, it is still a far cry from the US$3.8 trillion before the start of the pandemic and almost seven-fold from less than a trillion dollars before the global financial crisis (GFC) of 2008.

Warsh, a former Fed governor from 2006 to 2011, had expressed his views during the Senate Banking Committee hearing that he believes the Fed balance sheet should not be used as a tool to support the US economy.

Instead, he belives that the Fed should focus solely on monetary policy, and without attempting to distort markets.

While the idea sounds great on paper, past financial market crises have led the Fed to use all its necessary tools to reignite not only the US economy but also the rest of the world.

The ballooning US debt, which is on the way to hit the US$40 trillion mark, will make it difficult for the Fed not to use its balance sheet to support the market in times of financial or economic crisis.

At the same time, Warsh has not communicated to the market the ideal size of the Fed balance sheet.

This leaves much to market speculation as to where the Fed is heading in maintaining a balance sheet that is seen to be supportive of the US economy.

Rate cuts?

During the GFC, Warsh was known as a hawkish character, and his view was anchored on the belief that rate hikes are the answer to rising inflation.

However, over the years and especially since the Fed came under increasing pressure to lower rates from the current US President Donald Trump in the past year or so, Warsh has turned dovish and echoed the need to lower rates.

His guided belief that the United States can lower interest rates on the premise that the current inflation gauge, the core personal consumption expenditure (PCE), is not the right tool to explain the inflation pressure that the US economy is facing.

Hence, Warsh is now seeking alternative tools to measure inflation – one that will allow rate cuts to take place.

Trimmed mean

The trimmed mean PCE inflation rate is an alternative measure of core inflation in the price index for PCE.

A trimmed mean gauge removes the largest and smallest values before calculating the average.

Hence, a trimmed mean smoothens the results and is said to paint a more realistic picture.

Interestingly, while the core PCE rose 3.3% year-on year (y-o-y) in April 2026, the trimmed mean inflation gauge grew at just 2.3% y-o-y, down from 2.4% that was reported in March.

Shifting the goalpost

Warsh is hell-bent on lowering interest rates, but there are reasons to believe that he will not have it his way.

Despite a modest reading on the new preferred inflation gauge, the market is not buying it.

After pointing to the failure of the past Fed chair Jerome Powell as being behind the curve and waiting for far too long before cutting rates, Warsh is seen as determined to lower rates, which would please Trump, his No 1 fan.

The question now is whether Warsh is turning into a dovish central banker to the extent that he is willing to shift the goalpost by using a different yardstick to lower US interest rates.

Would this mean that since the trimmed mean PCE rate is closer to the Fed’s targeted long-term inflation target of 2%, the Fed is likely to abandon the core PCE as the sole yardstick to measure inflation?

How will the market react at a time when the benchmark 10-year paper, last seen at 4.48%, is already seen as hurting the US economy and the government’s borrowing costs?

Speak no evil

Warsh has another worldview that is contrary to market expectations.

He believes that the Fed does not need to communicate to the market its assessment of where rates are and where they should be going in the future, especially in relation to the Fed’s guided dot plots and economic forecasts.

In essence, Warsh wants to take a step back and be less transparent in the Fed’s forward guidance, which, in his mind, will be less volatile for markets as traders/investors tend to overreact to short-term shifts in economic or rate expectations.

The shift in communication strategy would be contrary to what markets are used to and that also goes against the mantra that the Fed’s strategy is 90% communication and 10% execution.

After all, managing expectations of the market via forward guidance is key to having a lesser element of surprise, as the market would have priced in the intended changes in the benchmark interest rate.

Independence

The Fed lives on its independence and away from the pressure of the executive branch, especially a siting US president.

However, as the Fed’s mandate is to maintain price stability and maximum employment, a low interest rate environment is not suitable when the economy is running with elevated inflationary pressure.

Under Powell, the Fed was under intense pressure to lower rates as demanded by Trump, who criticised the institution heavily for not doing so.

While Trump has commented that he wants the Fed to be independent during Warsh’s swearing-in ceremony, it is ironic that his previous comments when Powell was the Fed chair were the exact opposite.

For now, based on Fed Fund Futures probability, there is zero chance of a rate cut this year, and for next year, the market is in fact looking for one rate hike.

Warsh will be hard-pressed to justify any rate cuts this year, unless he shifts the goalpost in terms of what is defined as inflationary pressure, by adopting the trimmed mean PCE inflation rate instead of the core PCE rate.