A changing Federal Reserve

Hello and welcome to Global Research Unlocked, the interest rates and FX series. This podcast is based on our weekly client conference call, where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Sfiha Salim, head of European rates strategy.

Today is Friday, 24th of April. I'm joined by Aditya Bhav, head of U.S. economics research, Mark Cabana, head of U.S. rates strategy, and Alex Cohen, senior T-10 FX strategist. Our focus today will be on the medium-term outlook for the Fed and more specifically what key takeaways we can draw from Kevin Walsh's Fed nomination hearing.

Aditya, starting with you, most of the investors we talked to have been assuming that the Fed under Walsh's leadership would be leaning even more Dohish than it currently is and would respond more favorably to the call for cuts we are hearing from the White House. Has the testimony confirmed this bias? Thanks Sfiha and good morning, good afternoon everyone.

Thank you for joining us. So, I think what's really important to remember in terms of Walsh's testimony is that his target audience was not markets and it was not his future colleagues on the FOMC. It was only the Senate for that day.

The goal of that confirmation hearing from Walsh's perspective was to get confirmed, to get the votes, and to convince the Senate that he is not politically compromised. So what Walsh said, I think the most striking thing about what he said was that he didn't really make a compelling case for cuts. He hinted at them a bit indirectly, he talked about AI, he's expecting a significant productivity boom from AI, a lot of folks are, that's not a controversial view.

He didn't take that extra step and say, therefore we need to cut rates. In fact, what he said was, we can't bank on it, we can't bank on the productivity boom. And then in terms of the labor market, he said, we're at full employment.

He did say we have to look through some of the inflation overshoot, but he also said we're not quite there yet in terms of getting all the way back to target. So for many reasons, what I heard from Walsh was a pretty strong case to stay on hold for an extended period of time and not a very compelling case to cut rates. But again, I don't think that's going to be the same argument that he's using once he gets into the seat.

So that's also important to keep track of. You mentioned inflation and Walsh also discussed how the Fed should approach its inflation targeting mandate. Do you feel there could be a structural change on that front?

Walsh has some interesting comments on inflation. He said that he prefers to look at median or trimmed mean inflation rather than the core. And there's some validity to that argument because the core somewhat arbitrarily omits food and energy, whereas what the trimmed mean does, for example, is it just trims out the top X percent and the bottom Y percent for the PCE.

There are specific numbers that we can get into if anyone's interested. But the point is, it's agnostic about what ultimately gets trimmed out and what remains in the average. So there's a good argument for using those metrics.

The test for Walsh, however, will be in terms of consistency, right? So will he stick with those metrics when they are running above the core PCE? That's really going to be the test because otherwise there will be concerns about cherry picking.

Is he just looking at these metrics because, hey, trimmed mean is running at 2.3 percent, median is running at 2.8 percent, whereas the core PCE is running at 3 percent? Is that why he's looking at it? Or does he actually have an intellectual reason to shift to these other targets?

So look, he'll probably make the case to the Fed. Will the FOMC buy it or will they say, look, let's add it to the suite of things that we look at? And they probably already do look at it, look at these measures.

But let's not officially kind of commit to just the trimmed mean and the median and deemphasize the core. So they will also be concerned about changing metrics before they've actually hit that target. There's potentially other structural change there, and it's about Fed communication.

Do you think that can change meaningfully under Walsh? He does seem inclined to do less press conferences. He said that, you know, I would only want to speak at a press conference if there was something new to say.

I wouldn't want to necessarily just repeat myself. I think that's a pretty decent case to be made, to go back to quarterly press conferences. This is what the practice was until 2019, actually.

So he can do that unilaterally, what Yellen and Bernanke did, that's fine. He probably would want to get rid of the SCP. This is where things, I think, get a little bit more interesting.

He thinks that forward guidance makes the Fed less nimble. It's a reasonable argument. My pushback against that would be that the Fed, in my experience at least, doesn't feel particularly tied down by its forward guidance.

It can give hawkish forward guidance and then end up cutting rates. In fact, I would argue that's exactly what happened last July, for example. I don't think forward guidance makes the Fed less nimble, but OK, if he wants to believe that, that's reasonable.

To get rid of forward guidance, however, what can he do? So certainly he wants the entire Fed to speak less. He can't force others to speak less.

He can speak less, but then he'll just be undermining himself relative to the rest of the committee. He can technically just do away with the SCP. He can do this without a committee vote, but he'd be making a lot of folks unhappy.

And is that how he wants to proceed, given that he needs their support to cut rates? So if he gets rid of the SCP, he's taking away one way for them to express their potential disagreement with him, to express their opinions. And does that make them more vocal?

Does that make them give more forward guidance in their speeches? Does that make them dissent more? Those are the challenges that he'll have to face.

But in theory, he does not need a committee vote to get rid of the SCP. He can just do it unilaterally. Very interesting.

Coming back to press conferences and shorter-term outlook here, next week could actually be Powell's final press conference at the FOMC. Do you think we can get any surprises from him? I think Powell's going to sound hawkish next week.

For one, that's probably where the data are pointing on the inflation front. I don't think we've had any resolution of uncertainty, and the upside risks still linger around the impact of the Iran war. On the labor front, if anything, the data have improved a little bit.

You can believe it's seasonal, but then you would at least say that the data haven't deteriorated, right? So we've had this somewhat surprising pickup in the ADP data. I don't put a ton of weight on ADP, but the magnitude of the acceleration in job gain certainly has struck me.

March, job growth was very strong. The unemployment rate came down even on a three-month basis. Job growth appears to have picked up.

Jobless claims are down. So the labor data have either been stable or potentially showing some signs of green shoots. Inflation looks still problematic.

And then also just strategically from the Fed's perspective, given how much uncertainty there is, I think they are far better off just keeping markets where they are. So there's no point guiding markets in either direction right now. Just preserve that pricing of essentially a flat pot for the rest of the year.

And if you need to make a dovish pivot down the line, you can always do that, right? We know that from the last couple of years over the summer. Now the question for me is, does Powell go steps further?

How open-minded is he to hikes? He's certainly going to get a question around that. Forward guidance language is a big point of interest going into this meeting.

Will they change the forward guidance to show two-sided risks? If they do show two-sided risks, or even if they don't, he's going to get a question around this. How does he answer it?

How open-minded is he, again, to hiking rates? Does he give you any thresholds? I don't think he will, but I think that conversation would be really, really critical.

And in that context, I think also how does he talk about the risks around the war? So one of the things that we found very striking in the last week or so is the comments from Waller, and particularly Mary Daly. They're both doves, they're prominent doves, they're well-regarded on the committee.

And Daly said, it looks like the war is going to have a bigger impact on inflation than growth. That's a very strong statement, given how early we are in the game in terms of the economic impact, right? So if Powell says something like that, I think that would be very hawkish.

If he just says, look, upside risk to inflation, downside risk to labor and growth, and we'll see how it plays out, then I think that would be more middle of the road. So those are the kinds of things that I would be watching for in Powell's press conference. But it's potentially a swan song, and I think he's going to go out on a relatively hawkish note.

Great. That could be quite exciting. Could you remind us a detail of your baseline call for the Fed, therefore, for the rest of the year?

Yeah, sure. So we, with admittedly very low conviction, have two cuts in September and October. And it's premised on a repeat of some softness in the labor data over the summer, and the idea that inflation as well, headline is most likely going to peak this month, core, whatever pass-through is going to happen.

I think we'll have a good sense of that by September. You'll also have tariff effects rolling off the year over year. So there are a few things that could line up where Warsh coming in with a dovish inclination and the majority of the committee still probably leaning towards a neutral rate of three rather than three and a half.

Those factors could then kind of get them over the line just to do a couple of cuts. But again, I would not be surprised at all. If you ask me, how likely is it that they don't cut at all this year?

I would say it's a very, very close call. Very clear. Thank you, Aditya.

How do you perceive the balance of risk for the dollar in the context of this changing Fed leadership? Yeah. Thanks, Thea.

I guess at the risk of being overly simplistic, I would say Warsh in a vacuum is a bearish dollar factor. The reasons for that, I would say, are pretty fairly straightforward. As Aditya already mentioned, we know what the administration wants in terms of rates.

We also know what Warsh would have said to get the nomination, and it does seem like all else equal that he'll be a bit more assertive in pushing for these cuts once he's in the seat, even if, as Aditya noted, he didn't really make a particularly compelling case for that when speaking at his hearing earlier this week. But the critical thing here will be in order to get the rest of the committee on board, the underlying economic conditions and especially the labor market would need to have at least some directional consistency with that. That's the sort of weight and speed factor going in there.

But I think that's, I would say, a pretty conventional view in terms of what Warsh means for the dollar. The rub here, of course, is that the market is quite notably priced for the Fed to be on hold for quite some time. The upside here in terms of hikes under Warsh, we look at that as being asymmetrically higher bar for hikes versus cuts.

So if the Fed ultimately is not hiking when arguably it should be hiking, that would be a bearish dollar factor. And then, of course, if they are cutting aggressively, even if the labor market is softer but maybe not completely rolling over or completely cracking, we think that would also be a next bearish dollar factor as well. I think that's kind of how the market is really playing it for now.

And I would just note, too, at the hearing, it really was not a major influence on the dollar in the market. In the meantime, what do you think can be the most relevant drivers of the dollar in the near term? In the very near term, the market is just extremely headline-driven right now.

The recovery that we've seen in sentiments in the post-peacefire period after the first week in April has really pushed the dollar kind of smack back into the middle of the range that it has been in arguably since Liberation Day, and the dollar has been in quite a tight range. There's been a lot of false breaks on either side, and we're kind of right back to where we started in some ways after the dust settled around this time last year. So as long as we're in this, I think this kind of, let's call it, amorphous period related to peace talks, really expect this dynamic to continue.

Every day is just another day of kind of chopping back and forth on the headlines that come out related to the war, and it's sort of unclear exactly how this is going to shape up. People do think that there's this sort of de-escalation is kind of the bigger move that will happen at some point, but there's plenty of reasons to be somewhat suspicious of that as well. Now, beyond that, I would say just in terms of the near term being beyond this kind of chop fest that we're living through, we do think the next phase for the dollar will be more data driven.

The commodity team here continues to flag that oil supply risks are quite prevalent and really could start to get a bit more notice as the actual physical supply starts to become more constrained down the road. And this can linger on even well after any sort of hypothetical agreement is reached in the peace talks. So we do see that as something to be cautious of.

And from a dollar versus, let's say, other developed market perspective, we think that, just with the US being more insulated from the terms of trade shock, we do think that from a relative data perspective, the dollar could find some support on that. Right now, I think that's a bit premature for the market just given how short term everything is. I think it's going to take a few months for this to really show up in the global data enough to get things moving on the effect side.

Great. Thanks, Alex. Now, shifting to rates and on the balance sheet, how would you mark, it appears that Warsh has quite strong views on the Fed's balance sheet.

What is he aiming for on that front? Yeah, thanks, Svea, and thanks, everybody, for joining. On the balance sheet, Warsh has said really two things, at least to my ears.

One, he would like to reduce the size of the Fed's balance sheet, and two, he would like to adjust the composition away from longer term securities holdings. Everybody at the Fed wants a balance sheet that is really treasury only, but Warsh also wants to reduce maturities or the duration risk that the Fed is holding in their portfolio. How do you think he will proceed to achieve this balance sheet reduction?

Our view on Warsh has been that it's going to be more bark than bite. We think he's going to have a difficult time reducing the size of the balance sheet, but he will be much more effective in adjusting its composition. On the size, the Fed has, in my opinion, right-sized its balance sheet.

They've done as much QT as they can, and money market movements in Q4 of last year clearly reflected that the Fed could not drain its balance sheet anymore while still maintaining its objectives of a, quote-unquote, ample reserve regime. Once a central bank right-sizes its balance sheet, then the total size is fundamentally determined by its liabilities. If Warsh wants to shrink the size of the Fed's balance sheet, he's got to shrink some of its liabilities.

Now, the Fed has three big liabilities on its balance sheet. One, currency in circulation, which he's going to have a very difficult time having a big impact on. Two, the U.S.

Treasury's cash balance, which is about a trillion dollars and certainly could be reduced. But I think that that request really needs to come from the Treasury Department, not from the Fed. And I have never heard Treasury Secretary Besson say anything that would suggest he wants a smaller cash balance with the Fed, so that's going to be tough.

And then the third big liability that the Fed has is reserves. And this is really the only way, in our opinion, that he can reduce the balance sheet. Now, to reduce the size of reserves, he can do it in one of two ways, in our opinion.

He can do it in a bank-friendly way, or he can do it in a bank-unfriendly way. The bank-unfriendly way would see the Fed push money out, cap or tier the rate at which banks are being paid to hold cash with the Fed. And by doing this, banks would then be less optimally liquid.

And the consequence of having a less optimally liquid banking system is that you would have more volatile money market rates, and more importantly, you would likely have banks who are a little bit less willing to make loans. Think about yourself. If you're less optimally liquid, are you more or less likely to spend?

Are you more or less likely to take risk? You're less likely. And banks would be no different.

So he can do that, but it will potentially be a headwind to growth in the U.S. He's probably not going to do that. So then, really, the only way that he can do this is to reduce reserves through a bank-friendly way.

And that would occur through adjusting bank liquidity regulations. The official sector in the U.S. has already started to lay the groundwork for adjusting some of those liquidity regulations. What they will do is essentially count a wider set of collateral that banks hold as HQLA, or potentially monetizable assets, by pre-positioning some of that collateral with the Fed discount window.

And that is how they will potentially try and encourage banks to hold fewer reserves. So, Svea, I'm sorry that that was a long-winded answer, but I think it's important to just say it's going to be really tough for Warsh to do this. And really, the only shot he has is through bank liquidity regs.

And how much can he do it? We've written maybe $200 to $500 billion, which is about 10% reduction in reserve demand. We think it's going to be relatively small, relatively incremental.

And he actually probably won't be able to reduce the size of the Fed's balance sheet much. And it will likely be able to modestly slow its future growth. Thank you, Mark.

That's very clear. Maybe then he has a better chance at the other aspect of a reduction in the maturity of Fed holdings. How do you think he can go about that?

And are we talking about the Fed actually selling their long-dated Treasury holdings here? Yes. So, they can be much more effective, or Warsh can be much more effective, in adjusting the composition and the tenor of the Treasury holdings.

Could this be done through asset sales, selling longer-term Treasuries, buying shorter-term ones? In theory, yes. In practice, I would be shocked if that were to happen.

It's extremely unlikely in my mind. So they're very unlikely to sell assets and put meaningful upward pressure on the back end of the rates curve. And so instead what they will do is they will adjust the process by which they reinvest maturing Treasuries.

So right now what the Fed does is it takes, whenever it has a Treasury mature, it reinvests that proportionately in relation to what the U.S. Treasury is issuing. So for example, if the Fed has $10 billion coming due and it's a mid-month settlement and you've got threes, tens, and thirties, let's just assume that they're each 33 and a third, so one-third of a total $100 billion stock in each tenor, then the Fed would reinvest $3.3 billion in each one of those new securities offerings across threes, tens, and thirties.

What we think they're going to do is they're just going to adjust their reinvestment process so that they take all that $10 billion and they invest into the three-year in this example. Not by any tens, not by any thirties. And what that will do is it will reduce the weighted average maturity of the Treasuries that the Fed is holding.

We've run some simulations. We actually had some charts in our weekly just out this morning looking at that. They can reduce the weighted average maturity quite quickly by engaging in this process.

The Fed's weighted average maturity of the Treasury holdings today is about nine years. They can get down to six years and just about two years, then to three years and just about four years' worth of time. So they can go from nine to six in two or nine to three in four.

It can happen pretty fast, and we do think that this is the most likely way that it will occur. Notably, the market impact of this should be very minimal from the Fed's perspective, and the market impact will only be felt based upon how the U.S. Treasury chooses to offset the shift in Fed behavior if they choose to offset it at all.

Do you expect any changes or response from the U.S. Treasury to this? No.

None. So mechanically, what will happen is that the Fed will be shortening their weighted average maturity. They will technically be shortening the weighted average maturity of the outstanding Treasury debt as a result of this process.

And when they do that, then the question is, does Bethen care? Will he offset or not? We think very likely not.

And if Bethen does not offset this, then the total market impact will basically be zero. Now, importantly, Walsh wants to link balance sheet dynamics to cutting rates. He said that in the testimony, he said that in the past, and others at the Fed, such as Governor Myron, believe something similar.

They believe that there's an equivalence in terms of the size of the Fed's balance sheet and then how much you can cut rates. Now, I don't really believe that, but who cares? They do.

But if I'm right in that Walsh will not be able to reduce the Fed's balance sheet by very much, then is he going to be able to use this as a good case to cut rates? No. Instead, what I think he's going to likely lean on is by saying, well, we reduced the duration risk that the Fed is holding on its balance sheet.

Because we reduced the duration risk, that should allow us to cut rates. That's not a compelling argument. I expect he'll make it.

It's not a good argument. It's not a good argument because the reduction in the Fed's weighted average maturity didn't have a market impact. So why would you need to cut rates as a result of it?

You won't. So I think he'll make the argument, but I don't think it's going to be a very compelling one. And I doubt it'll be sufficient to convince his colleagues around the Fed, and I doubt he's going to be able to convince the market that there is a real equivalence there.

Thank you for joining us today. We hope you found this useful and that you'll tune in next week. Bank of America and B of A Securities are the marketing names for the global banking businesses and global markets businesses, which includes B of A Global Research of Bank of America Corporation lending derivatives and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America and a member FDIC Securities Trading Research Strategic Advisory and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including in the United States B of A Securities Inc, a registered broker dealer and member of FINRA and SIPC and in other jurisdictions by locally registered entities, copyright 2026 Bank of America Corporation, all rights reserved.