How Warsh Could Shape Fed Policy

0:04President Trump's pick to run the Federal Reserve, Kevin Warsh, now faces a quicker path to confirmation after the Justice Department dropped its investigation of current Fed Chair Jerome Powell on Friday. So what are the implications for Fed policy and markets if Warsh is confirmed as Fed Chair? I'm Alison Nathan and this is Goldman Sachs Exchanges.

0:28To discuss what we know about Warsh, his potential approaches to Fed policy, and the confirmation process ahead, I'm sitting down with Rob Kaplan, vice chairman of Goldman Sachs and former president of the Dallas Fed. Rob, welcome back to Exchanges. Great to be with you, Alison. Always nice to be here. So Rob, as always seems to be the case when we have you on here, there's a lot to talk about. But before we get into the policy of all of this, just wanted to level set. Can you give us an update on where we are in Kevin Warsh's confirmation process and how much uncertainty is still at play there?

1:03Regarding Kevin Warsh, I think the path is clear. Now that the Justice Department has dropped its case, it's at the inspector general. Warsh then is going to get confirmed. Senator Tillis has reiterated that. And I would expect Kevin Warsh to be in the seat for his first FOMC meeting in June. Rob, let me just ask you one more thing. This process has seemed unusually politicized. But given all of your experience and many years of the Fed, is that actually the case? Let me tell you the parts that created some political considerations. First of all, going back into the fall, the president called for Jay Powell to step down or to leave.

1:49And there was a question whether he could fire him. I actually think the criticism of Jay Powell on monetary policy, I think that's par for the course. Calling for him to leave early is unusual. the pursuit of Cook and the thought that they might be able to replace her early and have her leave created some political concern. And the big concern was that the administration would get control of the board of governors. And the fear in the fall was they might replace all the bank presidents or a number of them. That did not materialize either. Jay is still there. Cook is still there. And they just extended all the president's terms by five years.

2:31They did that in December. It wasn't reported on widely. And so I think now, despite the criticism, I think it's more of a conventional process going forward. Okay. So talk a little bit more about that. You have known Kevin Warsh, as we've talked about before, Rob, for many years. Again, remind us how you would generally characterize his monetary policy framework. So Kevin Warsh was a governor, remember, under Ben Bernanke during the global financial crisis. He is remembered as a lieutenant to Bernanke, but he's remembered even more for in, I think, 2011. He voted for another round of quantitative easing.

3:15But in the meeting, he said, I'm going to go along, but I don't think we should do this. And then he gave speeches afterwards saying he thinks it's a mistake. And so his signature from that point was, I think, to paraphrase, he thinks the Fed should have emergency power for the balance sheet, but the bar should be very high for using QE. And so he felt that in 2011. I'm sure he felt that post-COVID in 2021. One, use the balance sheet during emergency, but not beyond that. And he's been critical of the Fed for other things. But I think the balance sheet is the thing he's best known for. He's also, in some of these hearings and some of the statements and information we've gotten from him, has communicated a different approach on inflation metrics, on communication itself.

4:07How meaningful would any of those shifts be in practice? They'll be meaningful. So let's go in order what I think he'll do that's a little different than Jay Powell. Kevin Warsh will be of the view that Fed presidents should talk less. He believes, and I agree with part of what he's saying, that the Fed has used forward guidance too much, i.e. it has said, here's what we're going to do. The dot plot is a good example of giving people more forward visibility. And I think his worry is that dot plot boxes the Fed members in to a position. And I think you may see him either get rid of the dot plot or downgrade it and encourage Fed presidents to talk less.

4:51We already talked about his views on the balance sheet. He's going to work much more closely with Secretary Besant to try to manage the balance sheet. And I think he'll have some opportunities to do that. And then the last comment is he's been a big advocate, and I agree with this argument, just I disagree on the timing, that AI adoption will be disinflationary over the horizon. Chinese overcapacity manufacturing will be disinflationary. And I think he's right. The issue he'll have at the FOMC table is at the moment, particularly because of the war in Iran, inflation readings are going north, not south.

5:31And they're going to want to be more receptive to his arguments when they see evidence of greater improvement in headline inflation. Well, let's talk a little bit about the current policy stance and where we are. If he is confirmed, there's been a lot of discussion that it's not an easy task facing the Fed today. We have, as you referred to, rising energy prices pushing up inflation. We also have some signs that the labor market is cooling. So how would you expect him to balance that dual mandate as he takes over this new position? So there's what he's going to do, and then there's what would my advice be.

6:10My advice would be come into the job with a clean sheet of paper without any preconceived notions. Don't be rigid or predetermined. He argued in his confirmation, and he mentioned the Dallas trim mean. You may have noticed that, and I think you talked about other measures. He mentioned that the Dallas trim mean, just to explain, and I used to run the Dallas Fed, so we managed this in the sea, it X's out extreme moves to the upside or the downside. So right now we've got an oil price shock and the Dallas trim mean says we're going to exit out. So he noted in his testimony that the Dallas trim mean is running more like, I think, 2.3 or 2.4, not 2.75.

6:53quarters. The danger with the Dallas trim mean is when you have an individual spike in one or two items, the Dallas trim mean will carve it out. What tends to happen with an oil spike is over the months it bleeds out into other items. So what starts as an unusual item up starts affecting 20 or 30 items, sometimes a trim mean measure lags. And so I'd be careful again. I think you should look at the dollars trim mean and other indices, but you have to look at the whole dashboard and you have to look at the trend. And so I don't know whether when it's all said and done, he will look at other indices or overweight some versus others.

7:37I think you got to be careful about that. And I think this committee is pretty actually sophisticated about that. Well, the market seems to have a perception that Kevin Warsh is going to lean dovishly. So what do you make of that? I mean, how do you think rates could evolve over the next 12 to 24 months under him? And how much will the market prove to be right? I agree with the market that, and I do believe he will argue aggressively that the Fed should anticipate not what's going to go on the next three to six months, what's going to go on over the horizon. And again, AI disinflation, he uses the 90s as a good example of productivity improvements and Greenspan looking through them.

8:20He'll argue that. However, the market is also saying the odds of a Fed rate cut in 2026 are basically now near zero and the first rate cut won't be till 27. And the reason they're saying that is even though he'll argue that this committee is going to want to make sure they see visible evidence that inflation is moving back, not at target, but near target. And remember, this committee is scarred by transitory and other things where they predicted what inflation would do when they were wrong, and it scarred them. They want to be risk managers, not prognosticators. So there's going to be a debate, and he's going to have to contend with that.

9:05And what do you think, Rob? Do you think that the market's right, that we're going to be on hold? Yeah, I do believe that the Fed right now, you've heard me say before, pre-war was at neutral. The real Fed funds rate is three quarters to one percent at the inflation rate. That gets you to three and a half, three and three quarters pre-war. If anything, the war is going to push rates up. I learned from my 11 years being at the Fed or associated with the Fed that it's a lot easier to forecast labor market developments than it is inflation. And so I have a healthy respect for how hard it is to forecast.

9:43I would be reluctant to move until I saw demonstrable improvement in headline inflation. Only then would I be receptive to the argument about anticipating. I don't disagree with the argument, but I disagree with the timing. I mean, leading up to all of this, though, was a general feeling, if we just take a step back for a moment, that the Fed was in danger of becoming less independent because President Trump clearly picked Kevin Warsh, in part because he did have dovish views in some areas. Is that a valid concern, as we stand here today, with him poised to take over the Fed chair role? So I would remind people, as I've said, on regulatory reform, that's not politically dependent.

10:29It hasn't been politically independent for the last 20, 25 years. And on working more closely with the Treasury on the balance sheet, I think that'll be a little bit more gray. I think that's fine, actually. I think that's a good development. But to your point on the Fed funds rate, I do believe that he may lean to try to argue for disinflation. They may lean dovish, but he's got to get seven votes. And I think he won't have seven votes. He'll have to persuade. And so I think very quickly, the job of the Fed chair, the Fed chair, I don't believe can credibly be a dissenter. The Fed chair, his job is to, he doesn't get to do that.

11:11He has to manage the group. And so he's going to have to get himself in the middle of the debate. He's going to have to control. He's going to have to push. And so I think he will be politically independent. He'll have a leaning, but I think he'll be politically independent. And the fact that he's got a diversity of folks, first governors and then presidents who aren't going to be quickly replaced, they have longer terms, at least for the next two or three years and longer, he'll have to persuade. And I think that'll be a good thing for him. It'll be a good thing for the Fed. And do you think that'll also be the case when it comes to the balance sheet, as we've talked about?

11:46has some clear views there, but you think changes would be gradual and he's got to convince. Well, so on that, he'll have more power. And so let's just explain the Fed. The balance sheet ran as high as nine trillion. They've now run it to six and a fraction. I thought the last two trillion of QE they shouldn't have done. I argued at the time it was overdone, but they've now walked it back. Okay, so regulatory reform, liquidity ratio changing, supplementary leverage ratio changing will allow the banks, I think, to own fewer reserves. If the banks don't need to hold as much reserves, the Fed balance sheet can be smaller.

12:29And so I think there actually will be opportunities working with Besant to run further down the balance sheet. But I don't think Besant or Warsh are going to want to run it off so quickly that they put more upward pressure on rates. Our problem right now is the curve has moved up. The 10-year is over 430. And I think they're going to be reluctant to do anything abruptly that could cause rates to inch up. And so that will be the governor on how quickly they move. I would guess when it's all said, then they'll be more deliberate. Okay. Last question, Rob, then. So as Warsh takes over, What are you most focused on?

13:09What are you watching? What are you most worried about? I hear some inflation worry in some of your answers already. So let's go back to where we are. Pre-war, we thought, as you know, Jan Hatsius believed in our team, we were going to have two and a half percent growth and inflation might start to cool in the last half. Unfortunately, the oil price shock has put a dent in GDP forecast closer to two, 1.7 percent for the second half of this year. That's a big step down and prices are stickier. The probability of central banks cutting has been pushed out. That's why the curve has moved up. And so we still have to analyze the demand impact and the price impact of this war.

13:52But in order to do that, it's got to stop and the straight has to get open and we need to begin the healing process. Until we do, we're very much in the fog. And the Fed will do, I think, nothing but keep analyzing, keep trying to understand. They're a spectator a little bit to events that are out of their control. And so we'll have to see how these events in the Middle East unfold. Thanks, as always, for joining us, Rob. Good to talk to you, Alison. Thank you all for listening to this episode of Goldman Sachs Extinges, which was recorded on April 27th, 2026. I'm Alison Nathan. If you enjoyed this show, we hope you'll follow us on Apple Podcasts, Spotify, YouTube, or wherever you listen to your podcasts and leave us a rating and a comment.

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