Gold prices reverse early gains as dollar recovers from weekly loss
We are Fed Watchers. In his Senate Banking Committee hearing yesterday, Kevin Warsh suggested that under his leadership, we might have less to watch. He advocated ending current "forward guidance" practices, which means no more quarterly Summary of Economic Projections, including the Dot Plot (chart). He suggested that a press conference after FOMC meetings should only be held when there is "important news" to deliver, rather than as a mandatory, periodic routine. He implied that the volume of current Fed speaking engagements may be excessive and counterproductive to clear policy signals. Under his leadership, the Talking Fed Heads on the Federal Open Mouth Committee will talk less. Woe with us! What are we going to do for a living?
(1) Warsh on inflation. At least Warsh didn’t call for abandoning the 2% inflation target in his "regime change" (chart). But he argued for a "stricter approach" to inflation targeting and a "new inflation framework" to replace the current regime. Warsh heavily criticized the "Flexible Average Inflation Targeting" (FAIT) framework adopted under Jerome Powell in 2020. He described it as a "fatal policy error" because it intentionally allowed inflation to run above 2%, which he argued led to the post-pandemic price surge. He advocated for narrowing the Fed’s focus back to its "core mandate" of price stability, implying a return to a more rigid interpretation of the target.
Instead of changing the inflation target, Warsh wants to move the Fed away from using the PCED inflation rate. He explicitly stated a preference for "trimmed averages" and "median measures." However, they tend to understate inflationary pressures.
(2) Warsh on productivity. On a happier note, Warsh agrees with us that technological innovations (especially AI) are boosting productivity, which means the economy can grow faster without inflationary consequences. He argues that if AI creates a "productivity-enhancing wave," it acts as a "structurally disinflationary" force. He suggested that Fed models should be updated to account for the fact that this increased output can allow for lower interest rates without triggering an inflation spike.
Actually, all he needs to do is promote unit labor cost (ULC) inflation as the underlying inflation rate in the labor market (chart). Faster productivity growth slows ULC inflation, which is highly correlated with the headline CPI inflation rate. ULC inflation fell to 2.4% y/y in Q4-2025.
(3) Warsh on interest rates. While we agree with Warsh that productivity growth is improving, we disagree that this means the Fed should cut the federal funds rate. He believes that productivity growth lowers the neutral interest rate. We think it has increased, especially today, when so much money is pouring into technology capital spending. Stimulating an economy that is already stimulated raises the risks of fueling speculative excesses. During economic booms, interest rates need to be high enough to allocate capital rationally to avoid irrational exuberance.
Interestingly, markets are currently pricing in no rate cuts this year, with the first fully priced reduction pushed out to the October 2027 FOMC meeting (chart). Warsh is likely to be confirmed as Fed Chair sometime this year, yet he has had no impact on the markets’ rate expectations.
(4) Warsh on the FOMC. The federal funds rate is determined by a majority vote among the twelve voting members of the FOMC. Warsh would need to persuade a majority of the committee that lower rates are appropriate, which is a high bar in the current environment.
Most Fed officials seem to agree that the policy rate is already close to the so-called neutral rate, meaning it is only modestly restrictive at best. Moreover, the neutral rate itself is likely rising, as structural headwinds to savings and the AI-driven surge in investment exert persistent upward pressure, thereby equalizing savings and investment.
Downside risks to the labor market have decreased while upside risks to inflation have increased, driven by the energy price shock emanating from the Middle East conflict. This is not an environment in which a new Fed Chair can easily build a coalition that will advocate for rate cuts.
(5) Warsh on the Fed’s balance sheet. Warsh made clear he would prefer interest rate adjustments as his primary policy tool over large-scale asset purchases. He raised a distributional concern that is rarely aired in public: that expanding the balance sheet through Treasury purchases disproportionately benefits those with financial assets, helping wealthier households more than ordinary Americans. His long-term objective is to actively shrink the Fed’s balance sheet, which he characterized as having become an "unhelpful" and routine policy tool that entangles the Fed in political pressure.
Warsh argued that a smaller balance sheet would support lower rates, better inflation outcomes, and stronger growth, while also stressing that the process must be executed slowly, transparently, and in coordination with the Treasury. The Fed’s balance sheet exploded during the pandemic and has only partially unwound since, leaving Warsh with an enormous task if he is serious about returning it to a size that no longer distorts financial markets (chart)
(6) Warsh on sock puppets. President Donald Trump has made no secret of his desire for lower rates and has joked about suing Warsh if cuts are not delivered. Senator John Kennedy (R-LA) asked bluntly whether Warsh would be the President’s "human sock puppet." Warsh vowed to be "an independent actor, if confirmed." Democrats, led by Senator Elizabeth Warren, pressed Warsh repeatedly on whether he had made any private commitments to Trump on rates. He denied it.
We are not concerned about Fed independence. Our view mirrors that of Senator Thom Tillis (R-NC), who observed that Warsh "has to be" independent because he must "convince eleven other people" to vote with him. The Fed is a consensus-based institution, and concerns about its independence have, in our view, been overplayed.