TAKING THE HELM

FEDERAL RESERVE

Kevin Warsh was sworn in May 22 for a four-year term as chair of the Federal Reserve, a role that will grant him outsized influence over interest rates and the direction of the U.S. economy.

The 56-year-old former finance executive and adviser to President George W. Bush previously served on the Fed's board of governors from 2006 to 2011 — when the central bank had to navigate the fallout from the 2008 financial crisis. He rejoins the Fed, whose goal is stable prices and maximum employment, as inflation surges due to the Iran war and concerns linger about stagnation in the job market.

He replaces Jerome Powell, who served as Fed chair since 2018 and said he intends to keep "a low profile" as a Fed board member.

President Donald Trump nominated Powell to his first term as chair in 2017.

In his second term, Trump pressured the Fed to lower its benchmark interest rate and acted to exert influence over the central bank, prompting concerns about the institution's independence.

Trump said Warsh will have "full support" from his administration and he expects his nominee will go down as one of the Fed's "truly great" chairs.

"I want him to be independent and just do a great job," Trump said. He also noted, "Thankfully, unlike some of his predecessors, Kevin understands that when the economy is booming, that's a good thing."

Economic picture

In some ways, the economy Warsh inherits is similar to the one Powell faced when he was sworn in as chair in 2018.

In the first quarter of that year, the U.S. economy grew at an annual rate of 2% — identical to the Bureau of Economic Analysis' advance estimate for the first quarter this year. The unemployment rate was 3.9% in April 2018, and 4.3% in April this year.

The inflation environment, however, is different. Prices rose 2.5% year-over-year in April 2014, compared with a 3.8% increase in April this year.

"The biggest challenge he is going to face is an economy that's solid, employment that's fine but not spectacular, and inflation that's stubbornly above their 2% target by every measure," said David Royal, Thrivent's chief financial and investment officer.

Warsh also rejoins the Fed as consumers' optimism about the economy is at a record low. The University of Michigan's measure of consumer sentiment fell for the third straight month in May, to 44.8. Surveys of Consumers Director Joanne Hsu said 57% of survey respondents said high prices were "eroding" their personal finances.

Chief differences

Being no stranger to the central bank may help Warsh generate consensus among the Federal Open Market Committee, which sets the benchmark interest rate.

During his confirmation hearing, however, he suggested the Fed needs a new inflation framework and a communications style less focused on forward guidance.

"When the Fed speaks, the market reacts," ConnectOne Bank Founder and CEO Frank Sorrentino said, adding that's what Warsh wants to avoid.

"Sometimes it could be the precursor to what policy decisions they want to make, getting the market to sort of anticipate and move in that direction. I just think Warsh doesn't think that's a smart way of going about running an independent Fed, because you do run the risk now of politicizing the decisions."

He said Warsh also appears to be more forward-thinking when it comes to setting monetary policy than Powell, under whom Fed decisions depended on data available to policymakers at the time of their meetings.

What does he support?

While Warsh was once seen as someone focused on keeping inflation tame through higher rates, he recently advocated for lower borrowing costs.

Royal said there may be two reasons for that.

First, Warsh sees artificial intelligence-driven productivity as a potential disinflationary force. Sorrentino explained the logic: AI is expected to make work faster and cheaper, potentially leading to an increased supply of goods and services; prices could fall as a result.

The second reason, Royal said, is because Warsh also advocated for shrinking the Fed's balance sheet. Sorrentino said that likely would reduce liquidity in the economy, which eventually could lead to lower inflation.

Warsh believes "the Fed balance sheet is distorting the economy — there's too much cash running around chasing after assets," Sorrentino said. "What's the proof of that? Look where gold is, look where the markets are, and look where crypto is … They've been inflated."

What to expect

Historically, markets dipped after the confirmation of new Fed chairs. Royal said investors shouldn't be surprised if that happens again.

The next rate decision in mi dJune will mark Warsh's first as chair. Forecasters predict policymakers will hold the federal funds rate steady at a range of 3.5% to 3.75%.