The week that was
Another apathetic week saw the US Dollar (USD) retreat modestly, although not by much. Geopolitics remained firmly at the centre of market attention, particularly toward the end of the week after reports emerged that the US and Iran had reportedly reached an agreement aimed at extending the current 60-day ceasefire.
The deal, which still requires formal ratification, would reportedly pave the way for the reopening of the Strait of Hormuz and the gradual normalisation of global shipping flows. For markets, that represents a potentially important shift after weeks of concerns over energy supplies, trade disruptions and the inflationary consequences of elevated Oil prices.
Against that backdrop, the US Dollar Index (DXY) remained anchored near the upper end of its recent range around the 99.00 region, while US Treasury yields drifted lower across most maturities as investors reassessed geopolitical risks and pared back some of the more aggressive tightening expectations that had emerged earlier in the month.
On the data front, inflation remained the dominant theme. The Personal Consumption Expenditures (PCE) Price Index, the Federal Reserve’s preferred inflation gauge, surged to 3.8% YoY in April, heightening fears that the march towards the Fed’s 2% target remains frustratingly slow. Meanwhile, the second estimate of Q1 Gross Domestic Product (GDP) showed the US economy expanding at an annualised pace of 1.6%, missing expectations and adding another layer of complexity to the policy outlook.
The broader picture remains largely unchanged. Growth continues, inflation remains elevated and policymakers remain caught between upside inflation risks and signs of a gradual cooling in activity. That dilemma was once again reflected in the comments from Federal Reserve (Fed) officials throughout the week.
The Fed Warsh may inherit
Fed speakers repeatedly stressed that inflation remains the primary concern. Neel Kashkari (Minneapolis) warned that inflation risks now outweigh labour market risks. Philip Jefferson (Governor) said risks to inflation remain tilted to the upside. John Williams (New York) reiterated that inflation remains too high and that anchoring expectations remains critical. Alberto Musalem (St. Louis) openly acknowledged that there are scenarios in which rates may need to move higher if inflation fails to improve. Jeffrey Schmid (Kansas City) described inflation as “too hot”, while Michelle Bowman (Governor) and Anna Paulson (Philadelphia) both argued that progress on inflation has stalled.
Different officials expressed different degrees of concern, but the message was remarkably consistent.
Inflation remains too high.
The labour market remains broadly stable.
And the Fed remains in no rush to ease policy.
That consensus matters because it raises an increasingly important question for investors.
What exactly should markets expect from a Fed under Kevin Warsh?
The Good, the Bad and the Ugly
For much of this year, investors have treated Kevin Warsh’s expected arrival at the Fed as a potentially dovish development.
That assumption may prove premature.
Warsh has often criticised modern central banking, but not necessarily for the reasons many investors assume. While markets tend to focus on the prospect of lower interest rates, Warsh has frequently directed his criticism toward the Fed’s balance sheet, the expansion of excess reserves and the growing role of central banks in financial markets.
In other words, he has often worried less about where rates are and more about how much influence central banks have accumulated since the Global Financial Crisis (GFC).
That distinction matters.
The good is that the White House may get the Fed Chair it wants.
Warsh is widely respected across both policy and financial circles. He understands markets, has extensive central banking experience and has long argued that the Federal Reserve should return to a more focused and disciplined framework. For an administration increasingly frustrated with current policy, he offers both credibility and a fresh approach.
The bad is that investors may not get the dovish Fed they expect.
This week’s Fed commentary highlighted a central bank still deeply concerned about inflation, inflation expectations and policy credibility. Those concerns are not particularly different from many of Warsh’s own long-standing views. If inflation remains stubborn and growth remains resilient, there is little in his record to suggest he would be eager to sacrifice credibility simply to deliver lower rates.
The ugly is that satisfying everyone may prove impossible.
Trump wants lower rates. Investors want lower rates and abundant liquidity. Many Fed officials remain focused on inflation and preserving the institution’s credibility. Those objectives may not always align.
A future Warsh Fed could therefore find itself pulled in three different directions at the same time.
The White House may want faster easing.
Markets may want both lower rates and plentiful liquidity.
Policymakers may continue worrying about inflation that remains stuck well above target.
That leaves Warsh facing the same challenge confronting today’s Federal Reserve: balancing political pressure, market expectations and price stability.
Someone is likely to end up disappointed.
Possibly everyone.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money.
When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions.
The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
