What could be a stumbling block for Kevin Warsh and his policies as Fed Chairman

crude oil price is rapidly increasing. Inflation expectations are rising. In the futures market, it seems increasingly likely that the US Federal Reserve (Fed) will raise interest rates.

And then there’s Kevin Warsh and his stated desire to lower rates, and President Donald Trump’s edicts.

Even before Mr. Warsh’s nomination as the next Fed chairman is scheduled for a hearing, his ambitious plans for “systemic change” at the Fed are facing challenges. Most obviously, $100 a barrel oil prices and the threat of incipient inflation they pose run counter to Mr. Warsh’s desire to sharply lower interest rates.

But the challenges continue. Once seated, the new chairman is likely to face resistance on almost every aspect of his plan to rewrite the central bank’s operating system. Mr. Warsh is working to reduce the Fed’s balance sheet. As he told Fox News in July, the overhaul could include “breaking some necks” at the Fed, “because the way we’ve been doing it isn’t working,” and could mean personnel changes, new hires, and adjustments to the models of economic forecasting and communications strategies the Fed uses to communicate its policy outlook to markets and the public.

In all of these areas, Mr. Warsh could face institutional resistance from Fed officials, the Fed’s governor and governors, and markets accustomed to the Fed’s ways and generally reluctant to change. Just getting into the chairman’s chair will be a challenge for Warsh, whose hearings have been delayed by Sen. Thom Tillis’ dissatisfaction with the criminal investigation into Fed Chairman Jerome Powell. Mr. Tillis, R.N.C., said he would hold off on a Senate vote on Mr. Warsh unless the Justice Department drops its investigation.

At the heart of Mr. Warsh’s policy is his deep belief that the Fed has repeated its policy mistakes over the years. Warsh believes the mistakes the Fed has made, from maintaining an oversized balance sheet after the emergency of the 2008 financial crisis to missing out on the inflation caused by the pandemic, are rooted in the Fed’s very nature.

For Mr. Warsh, installing a new Fed chair — even if it’s him — isn’t enough.

“What the Fed needs is less groupthink and more robust discussion of ideas. I don’t like it when everyone follows the same model,” Warsh told CNBC last year.

Warsh, as is customary for federal presidential candidates, declined to comment.

For Warsh, the most important thing is that “the Fed’s credibility is everything.”

Through it all, the 55-year-old former Fed chief exudes a confidence that stands in contrast to Harry Truman’s archetypal ambidextrous economist – a quality that appears appealing to the president and could be essential to his efforts to reform the central bank. Warsh said that when you’re Fed chair, you not only need to get interest rates right, but you also need to “look like you know what you’re doing.”

The sharpest questions about interest rates could emerge soon, as Mr. Warsh is caught between his own and Mr. Trump’s wishes on interest rates and market expectations.

Markets are pricing in a 35-40% chance of a rate hike by December. No interest rate cuts are priced in for at least the next 16 months. 2 year treasury This suggests that the market, at least for now, believes fund rates will at best be stable rather than declining over time.

Even before the U.S. attack on Iran, futures markets had priced in just 50 basis points (bps) of rate cuts through 2026, suggesting that markets were not buying whether Mr. Warsh could deliver on President Trump’s demands for faster and deeper rate cuts beyond the long-term neutral rate of 3%.

These market decisions challenge Mr. Warsh’s main economic argument: that AI can rapidly increase the economy’s productivity and enable faster growth without triggering inflationary pressures.

Mr. Warsh’s views already have some skeptics about the Federal Open Market Committee. Chicago Fed President Austan Goolsby told reporters in February that the Fed should not rely on productivity growth to put downward pressure on prices.

“We want to be very careful. The economy could easily overheat,” he said. “Let’s be a little careful and be careful.”

Mr. Warsh has argued that it is possible to reduce interest rates while shrinking the Fed’s $6.7 trillion balance sheet. He argues that the Fed’s holdings are effectively raising interest rates and hurting consumers, and in doing so straying from the realm of other parts of government, which is proper fiscal policy.

“Wall Street money is too easy, but Main Street credit is too tough,” Warsh wrote in a November essay in the Wall Street Journal. “The Fed’s bloated balance sheet, designed to support the largest corporations in times of crisis gone by, could be significantly reduced.”

Warsh’s strategy is that shrinking balance sheets will free up capital to lend more money to the economy, and banks will trade reserves with each other, giving the Fed a better view of what’s happening in markets, which can include early signs of systemic stress.

All this may be easier said than done. Fed Chairman Ben Bernanke threw a tapering tantrum in 2013 at the mere mention of the possibility of tapering the Fed’s asset purchases. And when Mr. Powell lowered foreign exchange reserves too much in 2019, interest rates soared.

Warsh said he was wary of the risks of acting too quickly.

“A change in policy should not happen overnight,” he told CNBC last year. Since resigning from the Fed board in 2011, Mr. Warsh has spent the past 15 years working for legendary investor Stanley Druckenmiller, a position that Mr. Warsh’s supporters say has honed his view of the market.

If Mr. Warsh tries to trim his balance sheet, he will almost certainly be shedding some of the $2 trillion in mortgages held by the Fed, which could put upward pressure on mortgage rates. It would also violate President Trump’s order directing Fannie Mae and Freddie Mac to purchase $200 billion in mortgage loans to support the housing market.

Federal Reserve President Chris Waller said in a recent CNBC interview that he supports reducing the amount of reserves the Fed holds as long as banks’ demand for reserves decreases. This could be achieved, for example, through some regulatory changes already in place that affect what assets banks need to hold. But he opposes reducing reserves without reducing demand.

“To me, shrinking the balance sheet, keeping the demand for foreign exchange reserves constant, and moving towards scarce foreign exchange reserves is just foolishness,” he said. “But reducing reserve demand and shrinking the balance sheet accordingly is something that can be seriously discussed.”

Warsh also promises very visible changes in the way the Fed communicates its views to the public and markets. He suggested that Fed officials do not feel the need to contribute to the Fed’s so-called dot plot, which anonymously records individual preferences on the direction of interest rates.

He told the Financial Sector Conference in New York in the fall that the points were “not that important for policy management.”

Dots are a mainstay of Fed analysis because they help the market infer what Fed officials are thinking. Wall Street analysts regularly publish speculation about which points belong to which officials. Still, they are controversial. Markets focus on the median and often mistake it for a plan, even though they are derived from 19 separate forecasts and are not compiled into a policy forecast by the committee.

Warsh believes the Fed is oversharing with the public, highlighting a general concern he has about so-called forward guidance. The Fed relied heavily on forward guidance to keep long-term interest rates low during the Great Recession and made strong commitments to future easing policy. In Warsh’s view, forward guidance created problems for Powell and others in 2021 when inflation started to rise. The Fed had promised in its guidance that it would wait, so it waited to raise interest rates as inflation continued.

Warsh said the agency’s credibility was undermined by adhering to outdated forward guidance.

“They were kind of tortured because they told you what they were going to do. You have to get out of that. You should spend less time predicting the future and more time shaping the future,” he said on the Hoover Institution’s podcast last year.

If the Fed backs away from sharing its views, it could be unpleasant for markets and the public. Investors are watching every word the Fed chairman says at his press conference, as they expect with every interest rate decision. Federal Reserve officials are sought-after guests on TV and at conferences, and their words move markets. Officials themselves may resist the chairman’s attempts to rein them in.

Mr. Warsh will face obstacles to his policies, but he will hardly be powerless to carry them out. He would have several advantages if he were able to pass Senate confirmation.

One is the power of the chair itself. Mr. Warsh’s skeptics like to point out that he is just one of a dozen votes on the FOMC that determines interest rates, but the chairman is considered first among his peers and is thought to exercise his power in other, more subtle ways. The chair sets the agenda for committee meetings and directs the organization’s influential research staff. Chairs who wish to consider specific data will almost certainly have their wishes granted.

Warsh also has allies. The Federal Reserve is governed by a seven-member board of directors. Mr. Warsh will likely have support in several areas from Mr. Trump, Mr. Waller, and two other board members appointed by the governor and top regulator, Michelle Bowman. It remains to be seen whether President Trump will secure further appointments to the board, including Chairman Powell (who can remain in the governor’s office after the chairman change) and other governorships he may ultimately decide to resign before the end of his term. Mr. Warsh is also expected to be responsible for instructing the 12 regional banks on who to nominate in the event that their current presidents resign or retire.

Mr. Warsh also brings a compelling personality to the Fed table, rooted in his belief that the Fed is wrong, that the Fed is right, and that there is a better way to conduct monetary policy. The upside would be potentially lower interest rates, less volatility around the Fed and its announcements and press conferences, and ultimately more independence for the central bank, with a smaller economic footprint and less exposure to political crosshairs. The downside is that market volatility could increase, uncertainty could lead to higher interest rates, and the transition process could become unstable. To avoid that outcome, Mr. Warsh will need to convince his colleagues and the market that he has the right plan to overhaul the Fed.

And, of course, it will be critical that Warsh’s analysis of what’s wrong with the Fed and his prescriptions for fixing it ultimately proves right.