Opinions

Kevin Warsh’s Fed chair hearing in front of the Senate Banking Committee has been scheduled for 10am ET on Tuesday this week. While we expect he will maintain this narrative about the economy, recent developments have weakened the case for lower rates – labor-market data have stabilized, PCE inflation has surprised to the upside, and the war in Iran poses further upside risks to inflation. The nuance for Warsh will be how he balances a desire to lower rates over time with an economic backdrop that does not call for rate cuts at present. As of writing, we are not sure if the Senate Banking Committee hearing on Tuesday actually takes place. Senator Tim Scott (R-SC and chair of the Banking Committee) could postpone it if he thinks that would send a sharper message to Trump that without ending the DOJ investigation into Powell, there is no path ahead for Kevin Warsh's senate vote confirmation. If the hearing does take place, we expect Warsh to be quizzed on overall Fed independence, independence of the reserve banks, scope for rate cuts, change in FOMC communications, timeline on balance sheet changes & his own views on if Powell should continue at Fed as a governor. Given steadfast indications from Senator Tillis (R, North Carolina) that he will block any Fed nominees in the SBC until the DoJ investigation of Powell and the Fed has been resolved, we do not expect Warsh's nomination to make it to the Senate floor for a vote. The likelihood of this outcome was amplified this week by the president, who indicated that he has no intention to call off the DoJ investigation of Powell. These delays likely imply that the Warsh confirmation will remain stalled past May 14, when Powell's term as board chair ends. In our view, the most likely outcome is that Powell will remain Chair of the Board of Governors, and the FOMC, until Warsh's confirmation can proceed. The president stated this week that he would "fire" Powell if he remained in office beyond his official term,11 which we interpret as a signal that he intends to appoint an interim board chair from among the current board governors (likely Miran). His legal authority to do so is questionable and will likely be met with a court challenge. Even if Trump successfully inserts an interim board chair, our view is that Powell would most likely remain as chair of the FOMC. This is because the FOMC elects its own chair and, in January, designated Powell for this role, on a pro-tempore basis. To summarise, Next week’s confirmation hearing for Kevin Warsh will likely give him a platform to reiterate his views that rates should be cut, in part, as he argues for a reduction in the Fed balance sheet. No vote is likely to be taken, and Warsh will probably not be confirmed when Chair Powell’s term expires next month. We see no material policy change under a new chair who has only one vote and will need to mend fences and build credibility within the committee.

For the BOJ meeting, we expect policy rate to be left unchanged and rate hike policy to be maintained, while keeping a close eye on situation in Middle East. Currently the market is pricing in 48 bps of hike by end CY26 which looks reasonable to us. But under the new Takaichi administration whether this materialises is a different question. While the Japanese Trade Union Confederation (Rengo) will not have released its first set of results from this year's spring wage negotiations by the March MPM (they are due out on 23 March), the BOJ will have access to wage hikes at individual companies on the peak response days (17–19 March). JPY looks set to test their June’24 lows against USD around 161.7. We can expect verbal interventions at current levels too, but actual intervention might not happen before 162. Wrt the ECB meeting on 19th March, we see status quo in the 19th March ECB meeting. Financial markets are currently pricing around 47 bps of hike by Dec’26. Markets are pricing hikes in response to the upward shift in Brent crude oil and Dutch TTF natural gas futures curves, and the expected rise in HICP inflation in response. But we maintain our view that the ECB will keep rates on hold in CY26 though this view is based on an inherent assumption that events will unfold in a way that pushes Brent crude oil and Dutch TTF natural gas futures curves down to levels similar to prior to the conflict, and therefore the impact on the real economy will be limited. Wrt the 19th March BOE meeting, we maintain the view that the MPC will want to cut further towards the middle of its view of neutral territory (around 2-4%), and view cuts as most likely to occur in April and July 2026. But markets currently have priced out the two cuts and are now pricing in a 25-bps hike by end CY26 which looks stretched to us. There is a 3rd possibility also. We think a desire from the MPC to wait-and-see how inflation expectations develop risks the next rate cut being even later in the year than we expect. Our 2 cuts theory is based on the assumption that this is still not a 2022 type scenario. Households do not have the accumulated savings and pent-up demand that they had post-pandemic, and global value chain frictions (aside from those reliant on the Strait of Hormuz) are not present to the same extent. Furthermore, gas prices have not risen like they did in 2022.

We expect the FOMC to leave rates unchanged at their March meeting. Communications are likely to emphasize optionality, with risks increasing to both the inflation and employment mandates. Inflation data have surprised on the upside, and forward-looking signs of price pressures are emerging. Growth and labor data have been more mixed, but sharp weakness in the most recent employment report and some weakness in credit markets will likely keep officials focused on downside risks. We can expect the DOTS to remain more or less the same but long term rate projection can move a tad higher. Core PCE and PCE projections for CY26 might also move higher by 0.1 & 0.3 bps. In our view, a majority of officials remain comfortable with the current guidance, but there is a risk that Powell will begin to reflect some of the hawkish pushback in his post-meeting press conference. Market is currently pricing in only 23 bps of cut till Dec’26 which is different from our expectations of 2 cuts of 25 bps each in REMCY26. Hence, we recommend putting on 2*10 US SOFR steepeners at current levels of 25 for profit target of 40 with stop loss at 15. This also matches with the view that US fiscal issues might come to forefront as tariff revenues evaporate & war expenditures drive fiscal higher.

Historically, oil price spikes represented a significant negative shock to the US economy. Prior to the emergence of shale in the US, the impact was primarily one sided. Higher oil prices drove up energy costs for households and businesses, exerting a clear negative impact on economic output. However, with the emergence of shale energy in the US, the impact of oil price movements on economic activity has become more balanced. Although higher oil prices continue to represent a cost shock for households and most businesses, there is now a more meaningful offset from benefits to energy producers and through the export channel. Due to these offsetting channels, the growth impact of oil price shocks is fairly modest. A $20 oil price shock, similar to that observed recently, would have a small impact on growth. The peak effect is only about a one-tenth drag on the level of output one year ahead. The impact on the unemployment rate is about half. A $60 oil price shock would have larger effects – given the linear nature of the model the impact is three times the $20 oil shock scenario. With oil prices around $120 per barrel, real GDP would be depressed by about 0.2 percentage points over a year and the unemployment rate would rise by a tenth. Unlike real GDP and the unemployment rate, an oil price shock has a significant effect on headline inflation. Conversely, given the muted impact on activity, the pass-through of an energy price shock to core inflation is generally small. A $20 oil price shock initially lifts headline PCE inflation by about 70bps in the quarter of the shock, though the impact dissipates materially with only an 11bps increase for the year following the shock. The $60 oil price shock impact scales by a magnitude of three – initially headline PCE inflation is 2ppt higher, with the impact moderating to 35bps over the year. Simulations show that oil price shocks similar to those outlined above are initially a modest dovish impulse for the Fed. With growth adversely affected and the unemployment rate pushed modestly higher, while core inflation is mostly unaffected, the Fed can focus on the labor side of the dual mandate. That said, the calculus could be somewhat different in the current environment, where supply-side shocks (i.e., tariffs) have already kept inflation well above the Fed’s target. Which bias is correct – the dovish bias implied by the Fed’s model or the market’s belief in a more hawkish impact on Fed policy? The market appears to have agreed with the “wait-and-see” bias from the Fed, with the 2-year Treasury yield rising about 19bps since last Friday – down from a peak rise of nearly 20bps. Consistent with this move, the market removed about 17bps of easing from 2026 and now only anticipates about 44bps of reductions. This is in spite of a super weak Feb Non-Farm Payroll no. Taken together, we think this historical perspective reinforces a Fed on hold for the time being until clear evidence emerges that they should adjust policy. We continue to expect the Fed to cut rates twice this year (in June & Sep) once Kevin Warsh takes over as Fed Chair. We see brent in the range of 80-100 now unless there is an off ramp by either Iran or Trump. We see this off ramp as a low probability event as both parties do not see much losses in current scenario. Iran has already lost it’s supreme leader and seen the worst of aerial attacks. Their missile and drone capabilities are impacted but still enough to create nuisance value for civilian life in middle east. As long as they can ensure this sustained low intensity warfare continues with Strait of Hormuz effectively closed for transits, pressure is on surrounding gulf countries to put pressure on Trump to pull back. But Trump does not see many losses in his calculations as long as US equities are relatively unharmed. Only if S&P500 goes below 6500, Trump might start thinking of off ramps. Till then we can expect the current standoff to continue. This implies further downside to risk assets specially equities. US rates can remain elevated and DXY strong. Precious metals have seen their best days, and we see scope for large fall there in either scenario of a sustained war (stronger DXY leads to lower Gold/Silver prices) or a ceasefire (geopolitical risk premium vanishes leading to fall in Gold/Silver prices).

Friday morning President Trump announced Kevin Warsh as his nominee to replace Jay Powell as Chair of the Federal Reserve. This will be a four-year term set to begin in late May this year. We expect him to be confirmed on time, despite the current Tillis roadblock relating to the subpoenas. We do not anticipate any great change in monetary policy from his appointment alone. The FOMC’s process of rate setting is deeply embedded into the FOMC and will take more than a new Chair to upend. Warsh himself is of impeccable credentials. He is till date the youngest Fed governor. He became Fed governor in 2006 at the age of 35. He resigned in 2011 because of his well justified views on the efficacy of QE-2 unleased by then Fed. However, he never once dissented from an FOMC vote, although he did often publish an opinion in the Wall Street Journal a day or so after FOMC meetings, lamenting the need for the Committee’s actions. His discomfort was due to his genuinely hawkish views and his scepticism about the need for QE, the size and composition of the balance sheet it generated and the collateral some of the lending facilities accepted. When he was a Governor, Warsh said, “the Chair owns the room” in reference to the relative influence of the Chair and other policymakers. We believe the current FOMC might be slightly more cmplex than Bernanke's era. But eventually we expect Warsh to be a deft manager of the FOMC debate, it will take time and careful cultivation for him to get to the status his predecessors enjoyed. As the next Fed Chair, we expect him to not accept the status quo at the Fed and to bring fundamental changes to the Fed’s frameworks and the Alt-Keynesian mindset. The use of excessive force by the Fed will probably be behind us, and the Fed could strike a better balance of prudence and restraint. On the question of Warsh being a hawk or a dove, we believe deep inside Warsh is a genuine monetary policy hawk. His view has been that AI increases productivity and therefore potential growth but then it may not lower the neutral rate. Indeed, the nominal neutral rate could be higher, although the composition would shift to lower inflation and a higher real rate. Since the stance of policy is loosely based on comparing current rates to the neutral rate, the scope for cutting rates on the basis of AI may be quite limited. However, AI may as well offer a reason to cut rates in the short run, because it could weaken labor demand and so cut consumer spending, among other immediate effects. Hence, we expect only two cuts of 25 bps each in June’26 & Sep’26 and then a long pause till March’27. US long end yields might not like Warsh as he does not support QE but Dollar swoons on Warsh as seen in Gold & Silver correction since Thursday when news broke out about Warsh being the next Fed chair.

The FOMC is likely to keep rates on hold at its 29th January meeting, with guidance continuing to signal a higher threshold for future rate cuts. It might also signal that there is no expectation of action at the March meeting. Fed Chair Powell will likely reiterate that policy is “in a good place” to respond to future developments and that rates are currently “within a range of plausible estimates of neutral.” On the economic outlook, the policy statement & press conference might present a somewhat more upbeat view about the economy. The statement is likely to upgrade the growth assessment to “solid”, note tentative evidence that unemployment has stabilized, and hint at an improving balance of risks to the outlook. Powell press conference might have more questions on Fed's independence than macro economic data. Powell will likely be asked about the DOJ investigation into his Senate testimony as well as the recent Supreme Court arguments around President Trump’s attempt to fire Governor Cook. We expect Powell to largely avoid these questions, referring back to his 11 January video message without further comments. Our own expectations is on a long hold till May when Powell leaves as Chair & two cuts of 25 bps each in June & Sep as a new Fed Chair takes office. Currently the inflation employment dynamics are in a stable orbit implying no rush for cuts. We do see recent legal actions as raising the potential for Powell to stay on as a governor. Indeed, if the administration insists on following through with a criminal prosecution of Chair Powell, and Senate Republicans stand firm in not advancing nominees to the Federal Reserve Board, it is likely the FOMC would choose Powell to remain on as chair. But this is not our base case. We currently do not have any strong views on UST yields seeing the 10yr UST between 4.20-4.40 for short term. On DXY, the continuous erosion of policy stability from Trump administration has led to DXY weakness below 98 levels this week. Currently at 97.6 levels, we expect it to retest the Sep’25 lows of 96.5 levels. Markets will be more focused on the announcement of new Fed Chair. Our own view is Rick Rieder has the strongest chance of clearing senate confirmation. He is also a market friendly face and should be seen as +ve for Fed’s credibility as an independent central bank. Rieder also is an avid golf player which provides him a special bonding with Trump. Polymarket ranked the probability of a Rieder chairmanship at just 3% till last week. But on Friday afternoon, those odds jumped past 40%, putting him above former Fed Gov. Kevin Warsh as the leading contender.