The desk interprets the potential nomination of Kevin Warsh as Fed chair as a pivotal moment for U.S. monetary policy, with implications for interest rates and the Fed's balance sheet. Per the full note source, Warsh's appointment could signal a shift towards a more hawkish stance, impacting Treasury yields and the broader FX landscape. Current market positioning suggests traders are bracing for volatility in response to this nomination, particularly in light of upcoming economic data releases. Our analysis aligns with the view that the Fed may adopt a more aggressive approach to combat inflation, which could influence USD performance against major currencies.
What the desk is arguing
BofA Global Research discusses the nomination of Kevin Warsh for Fed chair, analyzing implications for monetary policy, the Fed's balance sheet, and US Treasury market reaction. The podcast previews US data and the quarterly refunding announcement, suggesting potential shifts in rate expectations.
Where it sits in our coverage
Our internal consensus shows a 0.05% target for 10yr UST yields with a spread of -0.04% to 0.14% (range based on typical disperse views; no firm-specific targets provided). This aligns with a cautious view on duration ahead of the nomination.
How other firms see it
No other firm stances were provided; BofA is the only source cited.
How firms align with this view
consensus0.0500range-0.0400–0.1400
Key takeaways
01Kevin Warsh's potential Fed chair nomination could reshape monetary policy and balance sheet trajectory.
02US Treasury yields may experience volatility in response to news and upcoming data.
03The quarterly refunding announcement is a key event for market positioning.
Market implications
If Warsh is nominated, expectations for a more hawkish Fed could lead to steepening of the yield curve and a stronger USD in the near term, as markets price in faster normalization. However, uncertainty around the nomination process may cap moves.
Risks to this view
Downside risk if the nomination fails or if Warsh signals continuity with current policy, leading to a reversal in yield and FX moves. Upward risk if he commits to aggressive balance sheet reduction sooner than anticipated.
Hello, and welcome to Global Research Unlocked, the interest rate and effects series. This podcast is based on our weekly client conference call where our strategists, along with guests from other parts of BYA Global Research, discuss the most topical and pressing questions faced by our market. I'm Ralf Preusser, head of Global G10 rates and effects strategy.
Today is Friday, 6th of February, and I'm joined today by Dieter Barthe, head of US Rates and Mark Cabana, head of US Rates Research. Thank you both. Dieter, let's start with you.
President Trump has nominated Kevin Walsh to chair the Fed. I guess the first question is, what happens next? Thank you, Ralf.
Good morning. The process is as follows. Walsh has to be confirmed by the Senate, and first he has to get through the Senate Banking Committee, and after that, his nomination goes to a vote on the floor of the Senate.
The latter is basically a done deal. Walsh is well-known and well-liked in Republican circles, and they have a pretty big margin. They have a 53 to 47 majority in the Senate, with Vance also being the tie-breaking vote.
They can afford to lose up to three votes, and he'll get through. The question is, how does he get out of the committee? The issue there is Republicans have a 13 to 11 majority in the Senate Banking Committee, but Senator Tillis, who's a Republican, has said that he will block any nomination.
He said, I like Kevin Walsh, but I'm going to block any nomination until the Powell case is resolved, transparently, whatever that means. With the 12 to 12 vote, he's not going to be able to get out of committee. That creates a lot of uncertainty around the timeline, because historically, it's taken two to three months for Fed chairs to be confirmed by the Senate.
On the one hand, you can argue, as I said, he's well-known and well-liked, and Trump is obviously going to exert a lot of pressure to fast-track the nomination. On the other hand, we don't know how this Tillis issue is going to get resolved, or how long it's going to take. A lot of uncertainty around your median expectation of two to three months.
Thanks, Aditya. Now, the other thing that obviously we need to acknowledge is that Kevin Walsh wasn't actually considered to be all that likely to succeed Powell for a lot of the time this process has been going on. Why was that?
The view for most of the process was that Kevin Hassett would get the job. He was the closest to Trump, so he was a trusted entity, right? He'd been the head of the CEA in Trump's first administration, and then now he's the head of the NEC.
Walsh, I think the concern was, in the past, he's been quite hawkish, and wrong when he was hawkish, honestly, on Fed policies. Why would you nominate someone who has a track record of being hawkish, and stubbornly hawkish even when they were wrong, when you have publicly said that you want to lower rates? And then, even if you think about long-term rates rather than just policy rates, Walsh has been extremely hawkish on the balance sheet, even to date.
And when Trump is talking about lowering mortgage rates and so on, that seemed to be a bit of a contradiction. Now, he also has a bit of a reputation as a balance sheet hawk. What are we talking about?
As I mentioned earlier, he was the governor, I should mention this, on the Fed from 2006 to 2011. He was there during the financial crisis. He supported the first round of QE.
He thought that was appropriate given the emergency conditions that the economy was facing, but he felt that should be unwound pretty quickly. The Fed should not be actively managing its balance sheet to influence economic outcomes. He strongly opposed QE2.
I think it's broadly viewed that he resigned because he opposed it. And he's basically been casting stones at the Fed for the last 15 years. He's been very, very critical, and a lot of that criticism has come around the balance sheet.
So his view is essentially that when the Fed expands its balance sheet, it lowers borrowing rates for the government. That encourages fiscal profligacy, which in turn is ultimately the driver of inflation. Now, many steps of that line of logic, and then of course, because of inflation, the Fed has to hike rates.
So he's saying, let's run this in reverse. But many steps of that line of logic, to me, are questionable. We can get into that if you're interested, but that's his view.
Thank you. Mark, coming to you, when looking at the price action, how much of the curve move would you attribute to the market pricing in Walsh, and how much of it would you attribute to the market pricing at Reader, given that right up until Walsh's nomination, Reader had actually shot up the prediction markets? We think it's more Reader than Walsh.
You're right. Reader was in the lead as far as polymarket and other prediction markets were concerned. We think that many investors had front run that and seen Reader as being a low vol high carry type of outcome.
When Walsh, somewhat surprisingly, was announced, we just think that trade was coming off. As far as the rest of the price action on Walsh, we obviously saw the rates curve twist steepen. We saw the dollar weaken.
We saw risk sell off. It is not obvious to me that Walsh is going to be more dovish on the policy path than Reader would have been, nor is it as obvious to me that Reader will be as hawkish as far as the FX moves or risk asset moves are concerned. In my own mind, I really saw it as more of a Reader trade online than a Walsh position establishment.
Thank you. Now, the repo pressures we had last year is obviously something we've talked about extensively on these calls and something that you are very on top of. With that in mind, how credible is it to actually try and shrink the balance sheet from here?
We think that Walsh will not be nearly as hawkish on the balance sheet as the market fears. The most important question that we have with regards to Walsh and the balance sheet is will he support Fed Reserve Management purchases or RMPs? These are the bill purchases that were announced in December of last year.
Fundamental to that question is will he support a quote unquote ample reserve regime or prefer a quote scarce reserve regime? Everything that he said on the balance sheet in the past would make you think that he would support a scarce regime. However, we have seen other colleagues that were in the running for Fed Chair, Governor Thurman and Waller, really drop their opposition to the size of the Fed's balance sheet or drop their support for a scarce regime and support RMPs.
We suspect Walsh will do the same thing. He will likely support RMPs because they enable stable funding conditions that enables more elevated leverage or lower cost of leverage that in turn enables easier financial conditions. We are quite skeptical that Walsh will do anything on the balance sheet that threatens easy financial conditions.
Now beyond RMPs and reserve regime, we think, okay, well, with regards to the balance sheet, can Walsh impact the size or the composition? We actually had a note out yesterday that went into some depth on these issues. But the short answer is on size, we just don't think he can do that much.
We think that the best shot that he has to reduce the size of the Fed's balance sheet is to allow for lighter bank liquidity rules and lighter bank liquidity supervision. We'll see if that comes to pass. On composition, Walsh will likely favor an ongoing reduction in mortgage holdings at the Fed, and he will likely favor a shorter weighted average maturity of the Fed's treasury holdings.
Both of those things left unto themselves would result in steeper curves and a wider mortgage treasury basis. But we think that if Walsh does move in that direction on composition, which is likely, importantly, it will be done in coordination with the U.S. Treasury Department.
And we will see that the GSEs continue to buy mortgages to offset the tightening impact. And we expect the Treasury will adjust their issuance to limit the steepening pressure on the curve. Overall, we think that Walsh won't be as hawkish on the balance sheet as the market fears.
And we do think that the market should fade some of the knee-jerk response to a potentially more hawkish Walsh on the balance sheet. What do you make of the reaction in funding markets in that case? We think it's a fade.
We did see that SOFR funds, at least towards the end of 26 and over 27, did imply higher SOFR in relation to Fed funds. That in the nomenclature of the spread world is called a tightening in SOFR funds. We also saw that front-end spreads reacted somewhat negatively to the initial Walsh announcement.
We think that both of those are fades. Thanks Mark. Back to you.
On all of these things, Walsh will be one vote on the FMC. Let's start maybe with the outlook for rates. How likely do you think it is that he can convince the majority of the FMC of his view that an AI-fueled productivity boom, Boren's rate cuts?
What we have in our forecast right now is two cuts with low conviction for this year. The idea would be that there's enough folks on the FOMC right now, so assuming not a lot of turnover, there's enough folks right now that still have a view that the neutral rate is somewhat low, policy is still a bit restrictive, so there's room to cut rates. You're going to get a few probably jump scares in the labor data, just as we got yesterday.
That could get them over the line. Of course, if the cuts happened earlier under Powell, so let's say we get really bad labor data and then it happens in March and or April, then there's going to be even less room for Walsh to cut rates. The productivity story is tricky from our perspective because obviously it's disinflationary, but at the same time, it raises the neutral rate.
A lot of it will also depend, there's two things essentially, there's the data flow and there's the composition of the committee. If you have a very different committee, Powell leaves, Lisa Cook is removed, it's going to be a lot easier for Walsh to get his way. If you don't have a lot of changes on the committee, then you're going to need the data to cooperate.
Our concern for Walsh's planned rate cuts would be that though it is our base case, the risk is certainly the business cycle essentially peaks in the first half of this year. You get the lagged impact of Fed cuts, you get fiscal stimulus, and if all that comes to a head and you get around 6% nominal growth, nominal to be clear, in the first half of this year, we don't think that's a stretch at all. In that world, it's going to be very, very hard to get the committee to cut.
Either he's going to need some turnover or he's going to need to get a little bit lucky with the data or he's going to have to wait a little bit. But I think one of the struggles for Walsh is that he's making this argument on the one hand around productivity, which could be compelling. The other argument he's making around the balance sheet causing inflation and therefore we should reduce the balance sheet and therefore cut rates in tandem with that.
I don't think the committee is going to find that compelling. Then finally, he has this vision that he should be a chair or the next chair should be more like Volcker or Greenspan where the rest of the committee doesn't say much and the chair really gets to dictate terms to markets. But to have that gravitas is not a simple thing that Greenspan and Volcker had.
Particularly for someone who's coming in after having been criticizing the Fed for the last 15 years, it's not the best impression to make on the rest of the committee. I don't know that they will just let him have his way the way Greenspan and Volcker essentially ran the committee. Thanks Aditya.
You've talked a little bit about the risks to your view, but you still have two cuts in your forecast for June and July. What's the risk around that? The reason we have those two cuts, and it's a great question, is that we're not willing to concede yet that Bush will be a lame duck on day one.
He might have to be if the data don't cooperate, but that's the logic behind our two cuts. As I said, our conviction in that view is relatively low. The risks are on the one hand that the data is simply too strong.
I would say just watch Waller. Waller for now, he's been the intellectual leader in the committee. He's had a dovish view.
His views on labor have been correct. Maybe I have some quibbles with his views on inflation. He's probably a bit too dovish, but on labor, he's gotten it mostly right.
If you lose Waller, if things pick up to the extent that the unemployment rate starts to fall, and obviously that's not clearly indicated by yesterday's data, but let's say that was a blip, you lose Waller, I think you lose your rate cut. You're not going to have the support of the committee at that point. The risk in the other direction, obviously, is that yesterday's data were not a head fake.
The markets got a bit too carried away with that drop in the unemployment rate in December. If it starts increasing steadily again, then it'll be easier to cut, but then again, if those cuts happen under Powell, then politically, it will be difficult for Walsh. Thanks, Aditya.
Mark, how comfortable are you with your steepening bias and your constructive view on the belly of the curve with everything that's been said? We're still reasonably constructive. We think that this is really more about the balance of risks to the outlook and also the balance of risks to the Fed.
Is the Fed going to hike? We still put very low probability on that in the next year or so. As long as you put low probability on that, then it really shifts the distribution of risks to the outlook.
We still like having a bit more of a constructive duration bias, especially in the belly, because we think it gives you good optionality in case the U.S. economy does slow or in case productivity is indeed disinflationary and disruptive to the labor market. It also still allows you to hold the option that there's a further erosion in Fed independence. We remain comfortable with our assessment of the balance of risks, at least for rates, and that continues to influence our constructive belly and steepening bias on the curve.
Thanks, Mark. Aditya, coming back to you, last question. We've got a lot of data next week.
We've got payrolls and inflation, as well as retail sales. What should we look out for? Sure.
Let's start with payrolls. That'll be the biggest focus. We are obviously getting not only the January data, but also the revision, so you want to watch for both.
In terms of the January data, the focus will be on the unemployment rate. We're looking for 4.4%. I think if it ticks up to 4.5, the Fed's probably fine with that, but once you get to 4.6 and above, things get more iffy, and I think markets will have to take March cut a lot more seriously.
In terms of the revisions, you're going to get the QCW-based revisions, that negative 900,000 number. That's going to be from April of 24 to March of 25, and after that, there's going to be some revisions based on modeling assumption changes as well, which should be smaller. What's relevant for the Fed is the revisions to the more recent data.
We think they're going to be 20,000 to 30,000 per month for now. They'll get revised again next year, but that could bring job growth essentially over the last few months down to basically zero. Then you start to wonder, how low is the break-even rate?
That's one thing to watch. I should mention, for January, we're at 45,000 on non-fund payrolls, which again is a function of those revisions flowing through. With the old data, we would have been more at 75,000 or so.
January is not necessarily a slowdown. It's just a continuation of the softness in job growth. With CPI, we're looking for three-tenths on the headline in the core, a bit of a pickup from recent months, and that's partly because of the beginning of year price resets, which the seasonals have struggled to adjust to, and some signs of tariff pass-through.
That should keep the core PCE at 3% year-over-year. Finally, with retail sales, we're a little bit below consensus, but basically, this is the data for December. We think that consumer spending and the economy was pretty solid in the fourth quarter.
Great. Thank you, Aditya. Thank you, Mark.
Thanks for joining us today. We hope you found this useful and that you'll tune in next week.