What could stand in the way of Kevin Worsh and his agenda as Fed Chairman?

oil prices are increasing. Inflation expectations are rising. The likelihood of a rate hike by the Federal Reserve is increasing in futures markets.

And then there’s Kevin Warsh and his stated desire — and President Donald Trump’s order — to cut interest rates.

Even before hearings are scheduled on her nomination as the next Fed Chair, Wersh’s ambitious agenda for “regime change” at the Fed is facing challenges. The most obvious: $100 a barrel oil prices and the threat of incipient inflation run counter to Warsh’s expectations of a sharp cut in interest rates.

But challenges lie ahead. The new president, once in office, is likely to face resistance on almost every aspect of his plan to rewrite the central bank’s operating system. Warsh has committed to reducing the Fed’s balance sheet. As he said, the overhaul may also involve “banging some heads” at the Fed. told Fox News in July“Because the way they’re doing business isn’t working.” This could mean staff changes or bringing in new people, as well as adjustments to the models used to forecast the economy and the communications strategy the Fed uses to convey its policy outlook to markets and the public.

In all of these areas, Warsh may face institutional resistance from Fed staff or Fed governors and chairmen, and from markets that are accustomed to change in how the Fed does business and generally. Even reaching the chair’s seat will be a challenge for Warsh, whose hearing has been delayed due to Senator Thom Tillis’ dissent over the criminal investigation of Fed Chair Powell. Tillis, R.N.C. Says he will block a Senate vote on Warsh unless the Justice Department drops that investigation.

Underpinning Warsh’s agenda is his deep belief that the Fed has made a series of long-standing policy errors. From maintaining too large a balance sheet after the 2008 financial crisis to missing inflation from the pandemic, Warsh believes the mistakes made by the Fed lie at the core of the institution.

Simply installing a new Fed chair — even if it’s him — isn’t enough for Warsh.

“The Fed needs a more robust discussion of ideas, less group think. I don’t like that everyone is following the same model,” Warsh told CNBC last year.

Warsh, in keeping with the practice of federal nominees, declined to comment.

To Warsh, one thing matters most: “Fed credibility is everything.”

Through it all, the 55-year-old former Fed governor exudes a confidence that contrasts with Harry Truman’s paradigmatic two-handed economist — qualities that appear to appeal to the president and may be essential in his effort to reform the staid Federal Reserve. Warsh said that when you are Fed chairman, you not only need to get interest rates right “Make sure you look like you know what you’re doing.”

Warsh’s biggest challenge may soon come on interest rates as he is caught between his own and Trump’s desires on rates and market expectations.

There is a 35-40% possibility of a rate hike in the market by December. No price cuts for at least the next 16 months 2 year treasury Trading near 4% is a sign that the market, at least for now, thinks the funds rate will remain stable for an extended period, not go down.

Even before the US strike on Iran, futures markets were projecting only a 50 basis point rate cut by 2026, suggesting markets were not buying that Wersh could meet Trump’s demands for faster, deeper rate cuts beyond the long-term neutral rate of 3%.

That market decision is a challenge to Warsh’s core economic argument that AI will rapidly make the economy more productive, so much so that it can deliver rapid growth without creating inflationary pressures.

The Federal Open Market Committee is already skeptical of Warsh’s view. Chicago Fed President Austin Goolsbee told reporters in February that the Fed should not rely on productivity growth to exert downward price pressure.

“You want to be very careful… you could easily overheat the economy,” he said. “Let’s be a little careful, let’s be alert.”

“Money is too easy on Wall Street and credit is too short on Main Street,” Warsh wrote in an essay in November. wall street journal. “The Fed’s bloated balance sheet, which was designed to support the largest companies in previous crises, could be significantly reduced.”

In Warsh’s game plan, a smaller balance sheet could free up money for more lending in the economy and banks would trade with each other for reserves, giving the Fed a true signal of what is happening in the markets, including possible early signs of systemic stress.

All this may be easier said than done. Fed Chairman Ben Bernanke caused a mild outrage in 2013 with the mere mention of the possibility of reducing Fed asset purchases. And Powell saw rates rise in 2019 when he greatly reduced reserves.

Warsh has said he is conscious of the risks of moving too quickly.

“Regime change in policy should not be done overnight,” he told CNBC last year. Since resigning as Fed governor in 2011, he has spent the past 15 years working for veteran investor Stanley Druckenmiller, a position Warsh’s supporters say has improved his perspective on the markets.

Any efforts by Warsh to reduce the balance sheet would almost certainly involve giving up some of the Fed’s $2 trillion of mortgages, which could put upward pressure on mortgage rates. It also appears to contradict Trump’s order for Fannie Mae and Freddie Mac to buy $200 billion of mortgages to help the housing market.

Fed Governor Chris Waller said in a recent CNBC interview that he supports reducing the amount of reserves held by the Fed, as long as banks’ demand for reserves has also fallen. This could be accomplished, for example, through some of the regulatory changes already underway that will affect how much assets banks are required to hold. But he opposes reducing reserves without reducing demand.

“Reducing the balance sheet, keeping reserve demand steady and moving toward scarce reserves, to me, is just foolish,” he said. “But reducing reserve demand and then shrinking the balance sheet accordingly – that’s something you can talk about seriously.”

Warsh is also promising highly visible changes to the way the Fed communicates its views to the public and markets. He has suggested that he does not feel obliged to contribute to The Fed’s so-called dot plot, where Fed officials anonymously record their personal preferences for the course of interest rates.

He said, “They were kind of tortured because they told you what they were going to do. You have to get over it. Spend less time predicting the future and more time shaping it.” Hoover Institution Podcast Last year.

A Fed that retreats from sharing its thinking could be unsettling for markets and the public. Investors keep an eye on every word said by the Fed Chairman in the press conferences they expect after each rate decision. Top Fed officials are sought-after guests on TV and at conferences, where their words sway markets. Officials themselves may resist the chair who tries to restrain them.

Although Warsh will face obstacles to his agenda, he will hardly be powerless to implement it. If he can get it through Senate confirmation, he will enjoy several benefits.

One is the strength of the chair itself. Warsh skeptics like to point out that he will be only one of a dozen votes on the rate-setting FOMC, but the chair is treated as first among equals and wields authority in other, more subtle ways. The Chairman sets the agenda for committee meetings and directs the organization’s influential research staff. A Chairman who wants to consider some data will definitely get his wish fulfilled.

Warsh also has associates. The Fed is governed by its seven-member board. Warsh is likely to get support in several areas from the two other Trump-appointed board members, Waller and Governor and regulatory chief Michelle Bowman. It remains to be seen whether Trump will get more appointees to the board, including the seat of Powell — who could remain as governor after being replaced as president — and other governors who may ultimately decide to resign before their terms are complete. Warsh will also likely play a role in directing the 12 district banks on who to nominate when current presidents leave or retire.

Warsh also brings to the Fed table an inspiring personality rooted in his conviction – that the Fed has got it wrong and they have it right, that there is a better way to do monetary policy. The positive side of this would potentially be lower rates, less volatility around the Fed and its announcements and press conferences and, ultimately, more independence for the central bank as its smaller economic footprint puts it less in the crosshairs of the political world. The downside is a potentially difficult transition process where markets become more volatile and rates become higher due to uncertainty. To avoid that outcome, Warsh will have to convince his colleagues and the markets that he has the right plan for overhauling the Fed.

And, of course, it will be vitally important that Warsh’s analysis of what is wrong with the Fed and his prescription for fixing it turn out to be correct.