Morgan Stanley indicated that a Federal Reserve led by Kevin Warsh might heighten volatility in the U.S. Treasury market due to reduced communication from the central bank. Strategists Matthew Hornbach and Martin Tobias wrote in a January 30th report, "Warsh is not inclined to let markets become overly reliant on the Fed's perspective. If market views diverge from his own judgment, he may not necessarily reinforce them." President Trump nominated Warsh last week to be the next Fed Chair, succeeding Jerome Powell, whose term ends in May. Warsh previously served as a Federal Reserve Governor from 2006 to 2011. A Morgan Stanley review of Federal Open Market Committee (FOMC) meeting minutes from that period suggests Warsh prefers investors to independently form their own judgments regarding economic growth, inflation, and monetary policy. Over the past year, while the absolute level of U.S. Treasury yields has fluctuated with changes in economic growth, the labor market, and inflation, the market's reaction amplitude to interest rate movements has significantly declined. This largely stems from the predictability of the Fed's policy path and its clear external communication. Current Fed Chair Powell stated last October that monetary policy is "more effective" when "the public understands what the Fed is doing and why." The Fed held interest rates steady last month. Traders broadly anticipate that the Fed is unlikely to adjust benchmark borrowing costs again until at least July. Since Warsh's nomination, traders have primarily focused on his stance regarding the size of the Fed's balance sheet and the appropriate level for policy rates. In Morgan Stanley's view, this former Fed Governor favors a "smaller balance sheet footprint," which would elevate long-term Treasury yields relative to short-term yields, thereby leading to a steeper yield curve. However, Morgan Stanley also believes potential changes in the Fed's communication style under Warsh, and the consequent increase in investor uncertainty, are equally critical factors. These changes could include: Fed officials reducing interactions with the media, especially preceding FOMC meetings; and potentially eliminating the dot-plot forecasts or the Summary of Economic Projections. Hornbach and Tobias stated, "Increased monetary policy surprises and a reduced likelihood of investor consensus on the future policy path should elevate actual volatility." Markets Live strategist Tatiana Darie noted that Warsh's skepticism toward "data dependence, forward guidance, or frequent Fed communication" could increase market volatility. For now, however, similar to the reaction seen after Besant's nomination for Treasury Secretary, the Treasury market has experienced some relief as Trump selected a more conventional candidate than previously expected. Nonetheless, not all investors believe a Fed led by Warsh necessarily implies rising Treasury market volatility. One reason is that, compared to other candidates Trump considered, Warsh might be more willing to foster coordination among Fed Governors. Jeffrey Palma, Head of Multi-Asset Solutions at Cohen & Steers, which manages over $90 billion in assets, said, "Warsh is perhaps the most likely among recent candidates to rebuild a degree of consensus. He is more likely to react to data and remain flexible, rather than being overly ideological."
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