Musical Chairs at the Fed
Powell’s last FOMC meeting may be next week.
Bottom line
Federal Reserve Chair-designate Kevin Warsh successfully navigated his contentious Senate Banking Committee hearing this past Tuesday, potentially clearing the way for him to replace Jerome Powell when the current chair’s term expires on May 15.
Just as significant is that Jeanine Piro, US Attorney for the District of Columbia, announced she was closing her criminal investigation of Powell and the Fed concerning the renovations to its headquarters in Washington. That is crucial because some Senate Republicans on the banking committee — most notably Sen. Thom Tillis (N.C.) — have joined the Democrat members to refuse to advance Warsh’s candidacy for a vote until the Department of Justice (DOJ) concludes that and another criminal probe. The other is Board Governor Lisa Cook over alleged personal mortgage fraud.
Is Powell’s investigation truly over? The short answer is yes, but Piro shifted its jurisdiction to the Inspector General. She also said she would reopen it “should the facts warrant doing so.” We think, however, that the book is firmly closed. Considering the DOJ’s investigation seemed to be a thinly veiled attempt by President Trump to influence the direction of the Fed’s monetary policy decisions, we might see Tillis and the banking committee relent and hold a favorable vote on Warsh’s nomination as early as next week. The next step is advancing Warsh’s confirmation to a simple majority vote of the full Senate before May 15 to keep the Fed’s leadership transition on pace.
Will he stay or will he go? But when Chair Powell’s current term expires on May 15, he can choose to remain on the Fed’s Board of Governors until January 2028. In the central bank’s 113-year history, that has only happened once before, when Marriner Eccles, chair from 1934 to 1948, stayed on as a member of the Board of Governor’s until 1951. Both Eccles and Powell said they were concerned about the integrity and independence of the Fed under Presidents Truman and Trump, respectively.
Two ‘popes’ is one too many If Warsh is not confirmed in time, Powell said he will serve as the Chair Pro Tempore. We will learn more next week both on the progress of the confirmation process and hear Powell speak to the press following the Federal Open Market Committee (FOMC) meeting Wednesday. A decision to remain could disrupt the dynamic among FOMC members. If Powell and Warsh were ever at loggerheads, how might participants respond?
Warsh, who was a member of the Board from 2006 to 2011 (during the global financial crisis), said in his opening statement on Tuesday that central bankers must be “strong enough to listen to a diversity of views from all corners, humble enough to be open minded to new ideas and new economic developments, wise enough to translate imperfect data into meaningful insight and dedicated enough to make judgements faithfully and wisely.” He envisions healthy, rigorous and respectful debate around the table. But having a former head sitting at the table with him might be too much.
But, as with the DOJ probe, Powell might make his decision based on a decidedly non-policy reason. He feels that the case against Cook is also politically motivated and has suggested he will not resign from the Board until she is vindicated. The issue is with the Supreme Court. If it is not concluded by May 15, expect to see two popes at this monetary policy Vatican.
Musical Chairs If Powell does not leave the Fed immediately, there will not be a place for Warsh on the Board. That is also unprecedented. As a result, the seat likely will be opened by the departure of Stephen Miran, who joined the Board last August. He replaced Governor Adriana Kugler, who resigned last summer, and her term expired on January 31. When Powell eventually exits, Trump may well appoint Miran to return.
Will Warsh channel Greenspan? Much like former Fed Chair Alan Greenspan during the technology build up in the mid-1990s, Warsh says he believes the AI revolution today is helping to boost productivity. He thinks this should allow the Fed to reduce interest rates because of stronger economic growth and lower inflation. Productivity in the US has risen by an average of 3.7% over the past three quarters, nearly double the 1.9% pace over the past half century.
Balance sheet hawk Warsh has suggested he is more adamant about reducing the Fed’s bloated $6.7 trillion balance than is Powell. If he pushes to cut it at a faster rate, it might lower short-term interest rates but steepen the yield curve. That could, in turn, reduce the Fed’s influence on the so-called wealth effect, which has boosted the value of hard assets, especially housing and the equity markets.
Fed independence is sacrosanct In response to a question at his confirmation hearing, Warsh said that “President [Trump] never asked me to predetermine, commit, fix, decide on any interest rate decision in any of our discussions, nor would I ever agree to do so.” That is critical, of course. We don’t want Congress or the White House making decisions about interest rates. Politicians are likely to lower rates because it can boost the economy in the short term and enhance re-election prospects, despite the potential long-term damage, in particular inflation.
Competence equally important Warsh also pointed to the need for "regime change" at the Fed. As inflation was soaring in 2021 due to excessive fiscal stimulus, the Fed neglected to hike interest rates, arguing that the inflation spike was “transitory.” They changed course by March 2022 and started to raise interest rates. But by then, inflation was soaring to 40-year highs in 2022.
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