The Warsh Era: What’s Next for the Fed and Markets

Overview:

On Friday, January 30th, President Trump announced his nomination for the next Chair of the Federal Reserve (Fed) as former Fed Governor Kevin Warsh. If confirmed by the Senate, Warsh will succeed current Chair Jay Powell, whose term expires in May.

We view this succession as one of the most consequential Fed Chair transitions on record. This is a pivotal era for the Fed for two primary reasons: (1) there is relentless debate over the Fed’s independence and the corresponding political pressure to ease monetary policy; and (2) the Fed’s dual mandate of balancing inflation with a healthy labor market is in extreme tension today. 

Warsh’s Credentials:

 Warsh brings extensive experience spanning Wall Street and Washington, possesses a deep understanding of the global financial markets, and is a persuasive communicator. Appointed to the Federal Reserve Board in 2006 at age 35, he became the youngest Fed Governor in history. During the Global Financial Crisis, Warsh served as the Fed's primary liaison to Wall Street until his resignation in 2011. In 2017, he was a leading candidate to succeed Fed Chair Yellen, though President Trump ultimately selected Chair Powell.

Warsh currently serves as an advisor to the Duquesne Family Office, led by legendary investor Stan Druckenmiller, as well as holding board positions at two public companies. Notably, Treasury Secretary Scott Bessent also previously worked with Druckenmiller. If confirmed, Warsh and Bessent would likely work in close partnership, potentially blurring some of the traditional boundaries between the Fed and Treasury. 

The Road to the Nomination and Confirmation :

Warsh has been among the leading Chair candidates for several months. Two weeks ago, President Trump narrowed the field after announcing that he wanted to retain then-leading candidate (according to the prediction markets) Kevin Hassett as Director of the National Economic Council. Warsh quickly emerged as the frontrunner to succeed Powell, edging out Blackrock's Rick Rieder and current Fed Governor, Chris Waller. We view Trump’s nomination favorably, as we view Warsh as more balanced and independent than the alternatives.

On paper, Warsh’s Senate confirmation appears straightforward given Republicans’ 53-47 majority in that chamber. However, the confirmation process may face complications. Senior Republican senators have indicated they will not vote on a new Chair while the Fed remains under legal scrutiny. In January, the Department of Justice (DOJ) launched a criminal investigation of Chair Powell related to his 2025 congressional testimony regarding the multi-year renovation of the Fed's headquarters. This probe appears politically motivated and lacks substantive merit, in our opinion. Nonetheless, Senator Thom Tillis, who sits on the committee overseeing Fed confirmations, has declared he will not support any nominee until the DOJ investigation concludes. Should the impasse persist beyond Powell's term, he would likely remain in office until a successor is confirmed. Given these elevated stakes, we expect a resolution by May, most likely with the DOJ dropping the case, potentially clearing the path for Warsh. 

The Importance of Fed Independence:

The Fed is an independent, self-funded agency that is accountable to Congress and the American public. Warsh has been a vocal proponent of how critical it is for the Fed to remain independent from political pressures. That is counter to President Trump’s aspirations, at least in his current term under the Powell regime. Trump has been angry that Powell hasn’t cut rates more, which may be related to the criminal investigation of Powell, as well as the administration’s attempt to fire Lisa Cook, another Fed Governor.

We remain strong advocates for the Fed’s independence from political influence. Economic and market stability depend on the Fed's singular focus on its dual mandate. In our view, Warsh's nomination helps to preserve this independence compared to at least one of the other candidates under consideration.

As we monitor these developments, it is important to remember the structural realities of the Fed. Monetary policy is a collective decision influenced by a wide range of economic views. The Chair holds only one of twelve equal votes on the FOMC, meaning Warsh can’t unilaterally lower interest rates. Warsh’s real influence will hinge more on the credibility he garners and his ability to build consensus among Fed policymakers.

Decoding Warsh's Policy Intentions:

As we study Warsh’s track record as Fed Governor, he was consistently north of the dovish/hawkish line. Warsh has maintained a rigorous focus on price stability, prioritizing inflation control over rate cuts aimed at juicing the economy. On the dual mandate, Warsh famously said: "Price stability is the North Star. Without stable prices, it is almost impossible to have full employment." 

Warsh has been a vocal critic of quantitative easing (QE) and the expansion of the Fed’s balance sheet. He characterized QE as a "reverse Robin Hood" policy that disproportionately benefited asset owners over wage earners. Warsh is a proponent of a smaller Fed balance sheet. The Fed’s balance sheet has retreated from a peak of $9.0TR in 2022 to the $6.6TR level today. Warsh would like to reduce that financial footprint further. 

Relatedly, Warsh has been openly critical of current Fed officials, which may have resonated with the Trump administration. Despite his hawkish track record, over the past two years, Warsh has advocated for tighter monetary policy, which contradicts Trump's preference for lower rates. However, during the nomination process, he expressed what the Trump administration is seeking: lower rates. Much of Warsh’s recent views stem from his argument that a productivity boom driven by AI and deregulation could coexist with disinflationary trends, which could combine to justify lower rates. 

Overall, the inconsistency of Warsh’s views creates uncertainty about his policy intentions. Three possibilities exist: (1) Warsh remains the hawk his track record suggests; (2) Warsh has genuinely evolved into a dove to secure the nomination; or (3) Warsh strategically adopted a dovish stance but will revert to hawkish policies once confirmed. Our base case is that Warsh will support modest rate cuts while simultaneously shrinking the Fed's balance sheet and reducing its market footprint. This would deliver the lower rates the Trump administration wants while maintaining his conviction that the Fed should be smaller and less interventionist. 

A Difficult Mandate: 

Wall Street Journal columnist, Greg Ip, summarized the monumental task ahead for Warsh as threefold: (1) shrink the balance sheet, (2) tame inflation, and (3) manage the President.1 Each presents its own unique challenge. Additionally, Warsh appears intent on streamlining the Fed’s communication to the public and overhauling some of the Fed’s tools and procedures. 

Those grand aspirations come at a time when extreme tensions exist in the Fed’s dual mandate. We’ve previously written about the economic crosscurrents that are making the Fed’s job so difficult. While job creation remains anemic at best, the labor market appears to have stabilized (“low firing, low hiring”). The unemployment rate recently ticked down to 4.4% and jobless claims remain muted. Importantly, U.S. economic growth has diverged from the labor market and remains resilient, with Q3 real GDP coming in at a blistering +4.4%, which appears similar to the projected Q4 level. The U.S. consumer is healthy, supported by aggregate wage growth that continues to outpace inflation, positive wealth effects, and the OBBB's "refund wave" that is anticipated to boost household spending in Q1. 

Meanwhile, inflation's "last mile" has proven stubborn. Services inflation remains sticky, shelter's disinflationary trend may be stalling, and goods inflation hinges on tariff outcomes. If inflation lives in the 2.5-3.5% range while job creation remains weak due to AI-driven productivity gains, yet the economy stays resilient due to strong corporate earnings and consumer spending, the Fed could face an extremely challenging policy environment. Given these tensions, the FOMC remains divided on the policy rate trajectory, as shown below from Oxford Economics.2 Warsh will face the difficult task of building committee consensus around a target that is both unclear and constantly shifting. 

Investment Implications: 

Short-Term Rates Outlook: 

As widely expected, the Fed held the policy rate steady at 3.50-3.75% last week following three cuts in late 2025. Markets are now pricing in two 25bps cuts by year-end 2026, one at midyear and another in Q4. That implies the December 2025 cut was likely the last of the Powell regime. Interestingly, 2026 rate cut expectations barely budged following Warsh's nomination last week. 

We think the policy rate is close to the neutral rate now. The 2-year yield, which has historically been a good predictor of where the Fed Funds rate is headed, stands at 3.58%, right on top of the current policy rate. We think this remains a “higher for longer” rates environment relative to the last two cycles. We hope the Fed is patient with cuts for now while inflation remains closer to 3% than its 2% target and the economy doesn’t need a shot in the arm. 

Intermediate-Term Yield Outlook: 

We’d issue the reminder that the FOMC only controls the Fed Funds rate at the short end of the curve. The broader market determines intermediate and long-term yields based on its views on inflation expectations, economic growth, and the overall desirability of owning U.S. debt. During the cumulative 175bps of cumulative rate cuts that began in September 2024, the 10-Year Treasury yield has actually risen by ~50bps over that time period. The 10-year stands at 4.28%, with the 30-year at 4.91%. 

Had Trump selected a more politically charged nominee, concerns about diminished Fed independence would have likely pushed long-term yields even higher. However, given Warsh’s stated desire to shrink the Fed’s balance sheet by reducing its bond holdings, intermediate and long-term yields may see upward pressure in the coming months. Our view remains that interest rate volatility is here to stay and that the “juice” of taking excessive duration risk across most fixed income segments is not worth the “squeeze” today. 

Equity Market Outlook: 

We expect incremental volatility in the months ahead as the rates and equity markets learn Warsh’s evolving views, as well as adapt to his desire for less forward guidance that we have come to rely on in the Powell regime. It seems likely that the market will test Warsh’s resolve. According to a Barclays analysis, the S&P 500 has averaged a 16% drawdown in the first six months following new Fed Chair appointments since 1930.3 

The current easing cycle has clearly supported U.S. stocks. If we get 1-2 additional rate cuts this year, lower borrowing costs would be a tailwind for corporate profits.

Conversely, Warsh's commitment to shrinking the Fed's balance sheet could push long-term yields higher and reduce liquidity, which could temper broad-based equity market gains. Encouragingly, market breadth has improved as equity themes/segments beyond mega cap tech have begun to participate more meaningfully. We expect that to continue in 2026. This remains a market environment that favors diversification, ownership of high-quality holdings, and extreme discipline. 

Summary:

President Trump's nomination of Kevin Warsh to succeed Jay Powell as Fed Chair marks one of the most important leadership transitions in Fed history. Warsh brings market and policy expertise to the role, with a “hawkish” track record that favors price stability over aggressive easing. His confirmation may face delays, but we expect resolution by May. 

Warsh inherits a Fed navigating stubborn inflation alongside resilient growth but weak hiring. His policy intentions remain unclear. His hawkish history suggests caution, yet his recent comments hint at being open to cuts if productivity gains support disinflation. Our base case: modest rate cuts alongside balance sheet reduction. 

For markets, Warsh's nomination preserves Fed independence better than alternative candidates. We expect rates and equity volatility as markets adjust to his evolving views and intentions for less forward guidance from the Fed. Disciplined, goals-based portfolio construction centered around diversification will continue to serve investors well. 

David Wrigley

Chief Investment Officer

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The information contained herein is the opinion of the author as of the date the market update was written and is subject to change without notice as markets change, and new information is available. While Diversify utilizes sources deemed to be reliable, we have not independently verified the content. Investors should carefully consider any changes based on this market commentary and discuss their individual circumstances with their trusted advisors. Past performance is not indicative of future results. This communication is for informational purposes only and should not be construed as investment advice or a recommendation.