Kevin Warsh’s path to Fed chair clears.

The S&P 500 and Nasdaq Composite closed at record highs last week amid Middle East conflict and testimony from Kevin Warsh, nominee for chair of the Federal Reserve (Fed). Fixed income markets were weaker. Treasury yields moved higher, with the 10-year closing at 4.31 percent.

BEYOND THE HEADLINES:

Kevin Warsh’s Path to Fed Chair Clears

Kevin Warsh, the Fed chair nominee, testified before the Senate Banking Committee on Tuesday as the first step in the confirmation process. On Friday, the path forward became clearer.

Senator Thom Tillis, a Republican from North Carolina and a key vote to move the nomination out of committee, had declined to support advancing the nomination until the Department of Justice (DOJ) concluded its investigation involving current Fed Chair Jerome Powell. On Friday, the DOJ closed that investigation. Over the weekend, Tillis said he would vote for Warsh. Warsh could be approved in time to lead the next Fed meeting in June.

How Would Warsh Differ from Powell?
Warsh reassured investors about how he intends to lead the central bank. His testimony emphasized support for Fed independence and his role in protecting it. He also made no promises about the next move on interest rates.

Warsh differs from Powell in terms of the size of the Fed’s balance sheet, how it measures inflation, and how it sets policy. He views inflation in terms of its impact on spending power and returns. He has indicated he would place less emphasis on economic models and less on forward guidance in setting interest rate policy. But the biggest difference may be his view of the Fed’s balance sheet. He has expressed concern that using the balance sheet shifts from setting monetary policy to establishing fiscal policy; instead, he argues for shrinking the balance sheet over time. He thinks the Fed’s expanded balance sheet has benefited asset prices while causing higher inflation.

Many investors came away from that testimony feeling that, in the short term, Warsh would be a steady hand who would be unlikely to make dramatic changes. The central bank is likely to continue to be data-driven in setting policy over the next several months as the impact of higher oil prices works its way through inflation data.

What Could It Mean for Markets?
If Warsh is successful in implementing his views, it could lead to more market volatility. A reluctance to use the Fed’s balance sheet as it has been used in the past could lead the central bank to tolerate more market volatility without stepping in to provide increased liquidity.

In his first term with the Fed, during the 2008 financial crisis, Warsh earned the reputation of being hawkish on inflation. His views on the central bank’s role could be beneficial for consumers; if inflation falls, purchasing power could improve over time.

The Bottom Line
Warsh represents a shift away from the “easy-money” central banking policies of the past two decades. Warsh would move the Fed toward restraint and discipline in its approach to monetary policy. That could lead to fewer policy safety nets and more market volatility. If successful, that shift could support stronger purchasing power over the long term.