On April 21, the U.S. Senate held a hearing regarding the nomination of Kevin Warsh for Federal Reserve Chair. Warsh's statements revealed the complex balancing act he faces. On one hand, he needs to appease former President Trump to some extent, thus acknowledging Trump's right to comment on interest rates. On the other hand, he must gain the trust of markets and the Federal Reserve internally, leading him to emphasize the Fed's price stability mandate and its independence. Although Warsh's performance under questioning from Democratic senators was less than ideal, this is unlikely to significantly impact his chances of succeeding Jerome Powell. The key to Warsh successfully passing the Senate Banking Committee vote lies in securing support from Republican Senator Thom Tillis. It is believed that Trump will likely intervene to withdraw the investigation into Powell to assist Warsh in passing the Senate vote. During the Q&A session, Warsh emphasized that he would not become Trump's "puppet," leading markets to lean towards hawkish trading. Warsh's ideas for reforming the Federal Reserve deserve market attention, particularly his proposal for a new inflation framework and his criticism of the Fed's current forward guidance approach. Warsh stressed that the Fed should reduce its balance sheet, with interest rates as the primary policy tool. However, it is still believed that Warsh's balance sheet reduction plan would require extensive preparation and proceed at a gradual pace.
The hearing, conducted by the Senate Committee on Banking, Housing, and Urban Affairs, primarily involved Warsh delivering an opening statement and responding to senators' questions. It did not involve a voting decision; the core purpose was a public review of Warsh's stance on monetary policy, his views on inflation, and the Fed's independence, among other key issues. Following the hearing, the committee will decide whether to schedule a vote and issue a recommendation. If approved, the nomination will proceed to the full Senate for a final confirmation vote, requiring a simple majority to pass.
Warsh's core statements included: 1) Comments on interest rates by the President and other officials do not pose a substantive threat to the independence of monetary policy; the Fed's independence primarily depends on the institution itself. 2) Inflation is a result of policy choices, and the Fed bears the responsibility for ensuring price stability—a mission that cannot be evaded or blurred. 3) Warsh criticized the expansion of the Fed's functional boundaries after the financial crisis, arguing that the Fed must "guard its boundaries" and that the greatest risk to its independence arises when it oversteps into fiscal and social policy areas. 4) Quoting Milton Friedman's "the tyranny of the status quo," Warsh emphasized the need for Fed reform.
Under the current Senate Banking Committee composition of 13 Republicans and 11 Democrats, if Democrats uniformly oppose the nomination, Republicans have only a two-vote safety margin. Republican Senator Thom Tillis has explicitly stated that he will block any Fed-related nominations until the Justice Department's investigation into Powell is concluded. His single opposing vote could trigger a 12-12 deadlock, preventing the nomination from advancing to a full Senate vote. Tillis's stance is not based on opposition to Warsh personally but rather on concerns about the Trump administration pressuring the central bank through judicial investigations. Given that Tillis has announced he will not seek re-election this year, it is believed that he will maintain his position. Conversely, Trump is likely to intervene to withdraw the investigation into Powell to assist Warsh.
First, in response to senators' questions, Warsh emphasized that he made no promises to Trump regarding interest rate paths and would not become Trump's "puppet," leading to a market bias towards hawkish trading.
Second, Warsh proposed greater focus on "trimmed averages" rather than the core inflation measure currently emphasized by the Fed. He argued that trimmed averages can filter out the effects of one-off events, providing a more accurate assessment of whether price changes will have further economic impacts.
Third, Warsh criticized the Fed's current forward guidance methods, such as the dot plot, suggesting the need for new communication approaches. He believes holding more than four FOMC meetings per year is appropriate. Warsh stated that interest rate paths are not pre-set and that, amid rapid AI development and frequent geopolitical changes, the Fed must maintain an open mind and respond flexibly.
Fourth, Warsh stressed that the Fed's balance sheet should be reduced, noting that interest rate tools have a broader impact on the overall economy, while balance sheet tools more significantly affect asset prices. The Fed should prioritize interest rates as its main policy instrument. Although Warsh demonstrated determination to reduce the balance sheet during the hearing, it is still believed that even if the process begins in the second half of the year, the Fed has sufficient reason to proceed gradually to avoid overwhelming market capacity for securities absorption, potentially requiring additional measures to ease market pressure.
Fifth, Warsh indicated that the U.S. is near full employment levels, aligning with the Fed's current focus on the unemployment rate rather than new job creation figures.
Risk factors include a weaker-than-expected U.S. labor market, unforeseen developments in the Middle East, unexpected Trump administration policies, and unexpectedly hawkish actions by the Federal Reserve.
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