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Understanding Kevin Warsh's Plan for the Fed · Trumponomics

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Speaker 1: Bloomberg Audio Studios, podcasts, radio news. I'll tell you if
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Speaker 1: our new head of the Fed, who I think is
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Speaker 1: going to be great, if he does the job that
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Speaker 1: he's capable, we can grow at fifteen percent. I think
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Speaker 1: more than that.
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Speaker 2: I'm Stephanie Flanders, head of Government and Economics at Bloomberg
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Speaker 2: And this is Trumpanomics, the podcast that looks at the
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Speaker 2: economic world of Donald Trump, how he's already shaped the
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Speaker 2: global economy, and what on earth is going to happen next.
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Speaker 2: This week, we look at what some would say was
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Speaker 2: the single most important personnel decision that Donald Trump has
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Speaker 2: made in the last year, choosing Kevin Walsh to be
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Speaker 2: the next Chairman of the Federal Reserve. Assuming Wassh is confirmed,
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Speaker 2: that's one piece of Trump Andnomics we can expect to
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Speaker 2: be shaping the American and globe bull economy for some
1:01
Speaker 2: time after the President himself has gone. So how will
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Speaker 2: mister Walsh lead the world's most important central bank? And
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Speaker 2: with relations between the Fed and the White House quite
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Speaker 2: so fraught, will he be able to win the internal
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Speaker 2: support he needs to be effective given the intensely political
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Speaker 2: build up to his appointment. For what it's worth, the
1:21
Speaker 2: market moves in the days when the choice of Kevin
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Speaker 2: Walsh was confirmed in mid January suggests investors think he
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Speaker 2: won't let policy be dictated by the president and won't
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Speaker 2: let inflation run a mup. You can see that in
1:33
Speaker 2: the rise and the dollar, and most strikingly in the
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Speaker 2: dramatic fall in the price of gold and silver. And
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Speaker 2: yet there are big areas of uncertainty about what Walsh
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Speaker 2: really thinks about monetary policy and interest rates, and about
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Speaker 2: his plans for the FED itself, which he's been pretty
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Speaker 2: critical of in the past. When I was thinking about
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Speaker 2: the people who could both understand this story and explain
1:56
Speaker 2: how markets were thinking about it, my friend Krishna Guha
1:59
Speaker 2: was the first name that came to mind. Krishner is
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Speaker 2: the vice chairman and head of Economics and Central Bank
2:04
Speaker 2: Strategy at the investment research group Evercore ISI. Before Evercore,
2:08
Speaker 2: he was an executive vice president at the New York Fed,
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Speaker 2: and we also overlap briefly at the Financial Times many
2:13
Speaker 2: years ago, where Krishna was a senior writer on global
2:16
Speaker 2: economics and economic policy. Firstly, I guess we had that
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Speaker 2: quite dramatic market reaction to his appointment, seeming the investors
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Speaker 2: drawing some quite clear conclusions about what he was going
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Speaker 2: to mean for the FED and not mean for the FED.
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Speaker 2: How did you interpret the reaction and what were some
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Speaker 2: of the key takeaways for you.
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Speaker 1: So we thought going in that the market would initially
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Speaker 1: trade Wash hawkish, so rates higher, yield curved steeper because
2:47
Speaker 1: of his balance sheet views and concerns that he might
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Speaker 1: restart QT to shrink the Fed's balance sheet, risk off
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Speaker 1: in stocks and dollar higher, as he would be seen
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Speaker 1: as more of a strong dollar candidate. So the market
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Speaker 1: reactions that we've seen, which have broadly gone in those directions,
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Speaker 1: I don't think are surprising. At the same time, though,
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Speaker 1: my own view is that the market reaction also reflects
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Speaker 1: a sense that people don't really understand exactly what kind
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Speaker 1: of central bank governor Wash is going to be. I
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Speaker 1: think that's reasonable. My own views are that Kevin Walsh
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Speaker 1: is unlikely to be an ideological hawk and is more
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Speaker 1: likely to be in many respects quite pragmatic.
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Speaker 2: Yes, So let's talk about the monetary policy kind of
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Speaker 2: interest rate piece first, and then we'll get into that
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Speaker 2: the balance sheet things, which for some people will be
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Speaker 2: less familiar territory. The reason I guess that there is
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Speaker 2: a bit of uncertainty about him is on this point,
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Speaker 2: is that he had previously been a hawk, and in fact,
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Speaker 2: as our own chief US economist pointed out, if you
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Speaker 2: look at his record, he was at the FARED two
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Speaker 2: thousand and six twenty eleven, he was more concerned about
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Speaker 2: inflation for longer than most governors. So if you look
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Speaker 2: at the sort of minutes, it was more worried about
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Speaker 2: inflation than downside risk as late as April two thousand
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Speaker 2: and nine, so right through two thousand and eight and
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Speaker 2: April two thousand and nine, and only really eased up
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Speaker 2: on worrying about inflation August two thousand and nine. So
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Speaker 2: it's quite striking to hear him now since he's been
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Speaker 2: in the running to be Trumb's pick for FED chair,
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Speaker 2: emphasizing a rather different approach, seemingly rather different approach, but
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Speaker 2: he's pinning it on the impact of AI on productivity
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Speaker 2: on the economy, and that's what he can say has
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Speaker 2: changed since two thousand and nine, And do you take
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Speaker 2: that at face value?
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Speaker 1: So I think it is true that Kevin Walsh has
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Speaker 1: for most of his career has channeled and represented what
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Speaker 1: one might think of a small C conservative Republican leaning
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Speaker 1: economic thinking and principles, there has generally been more concerned
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Speaker 1: with inflation than the labor market, let's say, more focused
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Speaker 1: on supply issues than demand side management. And so I
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Speaker 1: think there is an aspect that is channeling a set
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Speaker 1: of thinking on one side, if you like, of the
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Speaker 1: political and economic debates. But I think what Kevin would
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Speaker 1: say if he was on this call is that there
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Speaker 1: is a consistency in the way that he thinks about
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Speaker 1: inflation risks. So, first of all, Kevin is someone who,
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Speaker 1: as I mentioned, thinks that a lot of fed type thinking,
5:27
Speaker 1: a lot of New kaynes In type thinking, and the
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Speaker 1: modeling that's come from that puts a lot too much
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Speaker 1: weight on the demand side of the economy and unemployment
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Speaker 1: as a predictor and driver of inflation. Kevin's view is
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Speaker 1: that when the economy strengthens, or indeed weakens, the first
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Speaker 1: question you should be asking is whether it's supply driven
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Speaker 1: or demand driven. And then, of course the implications of
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Speaker 1: the economy are potentially very different, as are the implications
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Speaker 1: for rates in those two cases. I think it's also
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Speaker 1: the case that Kevin believes that the really big inflation
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Speaker 1: risks come when you have a combination of fiscal expansion
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Speaker 1: on the part of the government and money financing on
6:07
Speaker 1: the parts of the central bank. Now, of course the
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Speaker 1: FED would argue that it hasn't been doing that, But
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Speaker 1: Kevin would say, the government issues bonds to finance fiscal
6:15
Speaker 1: stimulus on Monday, and the FED buys bonds in the
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Speaker 1: market on Thursday, it's coming fairly close to money financing
6:22
Speaker 1: that fiscal expansion. So with respect to the GFC in
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Speaker 1: all Canada, my own view at the time as now
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Speaker 1: was that Kevin is simply wrong in his assessment. But
6:32
Speaker 1: if we think of, say, the difference between where we
6:33
Speaker 1: are now and the early phase of the pandemic inflation,
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Speaker 1: Kevin would have said, what do we have then? We
6:39
Speaker 1: had an impaired supply side, We had a lot of
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Speaker 1: fiscal stimulus, and we had a central bank that was
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Speaker 1: money financing and expanding its balance sheet. That, in Kevin's world,
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Speaker 1: is a recipe for high inflation. What do we have today?
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Speaker 1: We have a positive supply shock. We have a large
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Speaker 1: government deficit that Kevin certainly thinks in the long run
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Speaker 1: is not likely to be sustainable at these levels. But
7:02
Speaker 1: it's not going up or down because the tariff take
7:04
Speaker 1: is roughly the same as the one Big Beautiful Bill
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Speaker 1: fiscal giveaways, and there's no central bank money financing or
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Speaker 1: balance sheet expansion. So Kevin would say the inflation risks
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Speaker 1: today are completely different from the inflation risks that were
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Speaker 1: there in the early phase of the pandemic, which is
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Speaker 1: why I was a hawk then and I'm a dove now.
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Speaker 2: And obviously there's a lot of uncertainty about what the
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Speaker 2: impact of AI is going to be on the economy,
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Speaker 2: And there are many people who can look at where
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Speaker 2: inflation is now in the US and the sort of
7:33
Speaker 2: possibility that you will actually have a fair amount of
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Speaker 2: stimulus coming down the track as a result of the
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Speaker 2: Big Beautiful Bill and other things. So I get the
7:41
Speaker 2: jury is out on what happens to inflation over the
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Speaker 2: next year or two, whether it makes sense to continue
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Speaker 2: cutting rate or Eve cut them faster after Kevin wash,
7:52
Speaker 2: assuming he becomes fed chair but you know him pretty well.
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Speaker 2: How much is he going to be data driven? Now?
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Speaker 2: Much is he going to be willing to sort of
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Speaker 2: change his mind in the face of the evidence or not.
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Speaker 1: Yeah, Kevin's ideal central Bank governor is someone who would
8:06
Speaker 1: be fifty percent Alan Greenspan fifty percent stand Drucamiller. Why
8:10
Speaker 1: green Span because green Span was, of course the man
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Speaker 1: who knew he was the one who would look in
8:16
Speaker 1: the fine detail of the obscure economic statistics and private
8:20
Speaker 1: sector data and discern what was really happening in the
8:23
Speaker 1: economy that would show up in the official data many
8:26
Speaker 1: months in the future. And then, of course Drucamiller being
8:29
Speaker 1: by many counts one of the greatest macro hedge fund
8:33
Speaker 1: managers and somebody who had the ability to see in
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Speaker 1: market the signals about not just where the economy is today,
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Speaker 1: but where the economy would be going in the future.
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Speaker 1: So what Kevin will aspire to do is to have
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Speaker 1: a more forward looking and richer, more nuanced sense of
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Speaker 1: the outlook for the economy and the bounds of risks
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Speaker 1: then you would get by simply plugging last month's employment
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Speaker 1: report or CPI data into a model like FRBUS at
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Speaker 1: the FED. So he's quite scornful of some of those
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Speaker 1: models and the sort of culture of what he would
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Speaker 1: say is backward looking data dependency. So I think he
9:11
Speaker 1: will try to be yet informed by data, but putting
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Speaker 1: more weight on some of the sort of micro corporate
9:18
Speaker 1: level data on the one hand, and market signals as
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Speaker 1: data on the other, relative to, if you like, the
9:25
Speaker 1: top tier economic releases. What I would say with respect
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Speaker 1: to that approach is that I have I have a
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Speaker 1: lot of sympathy with the idea that we should, we
9:35
Speaker 1: really should aim to do better than simply used last
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Speaker 1: month's data to understand where the economy is going. We
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Speaker 1: do aspire to have a rich understanding of private sector
9:44
Speaker 1: data market signals. But it's very hard to be Alan
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Speaker 1: Greenspan and it's very hard to be Stan Ruckermiller, and
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Speaker 1: being a not very good version of those two could
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Speaker 1: be quite dangerous. So it's going to be a big
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Speaker 1: challenge to be able to do this in a way
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Speaker 1: that is very sophisticated and successful, and an additional challenge
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Speaker 1: in making policy in a systematic and predictable way when
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Speaker 1: you are, for good reasons, trying to draw in more
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Speaker 1: private sector insight and more markets insight as well as
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Speaker 1: standard macro data.
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Speaker 2: Yeah, I guess this gets a little bit how we
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Speaker 2: think he's going to get on with people at the FED.
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Speaker 2: But I guess the people who are who would be
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Speaker 2: concerned about that combination that you talked about. And to
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Speaker 2: your point, he doesn't have the background of Valan Greenspan.
10:33
Speaker 2: It's easy to be snobby about non economist FED chairs.
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Speaker 2: J Powell not done so badly. He's a non economist.
10:39
Speaker 2: Christine Legard was also a lawyer like Kevin Walsh. So
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Speaker 2: it doesn't seem to be unfortunately for US economists, it
10:45
Speaker 2: doesn't seem to necessarily be in a bar to being
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Speaker 2: a good FED chair Central Bank governor. But when you're
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Speaker 2: pinning a lot on this argument about how a technological
10:57
Speaker 2: change is affecting the real economy, is that going to
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Speaker 2: give him some persuading to do the FED making that case,
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Speaker 2: trying to get people on side with that, when actually
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Speaker 2: he's been a bit rude about some of the people
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Speaker 2: inside the FED, and he's even talked about the need
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Speaker 2: for regime change and breaking some heads and all these
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Speaker 2: kind of phrases.
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Speaker 1: Yeah, so, certainly as a bit of a repair job
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Speaker 1: to do in terms of his internal relationships at the FED,
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Speaker 1: which will be important for his success. And you know,
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Speaker 1: I think if he's smart, which I know he is,
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Speaker 1: and if he has enough slack from the administration, which
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Speaker 1: I'm not so sure about he will dial down on
11:38
Speaker 1: the MAGA regime change stuff from here on in, because,
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Speaker 1: of course, even if you're approaching this from the perspective
11:46
Speaker 1: of trying to deliver the several rate cuts of the
11:49
Speaker 1: administration is hoping for this year, your ability to do
11:52
Speaker 1: that is much greater if you are able to win
11:55
Speaker 1: over the if you like the old FOMC, get them
11:58
Speaker 1: on side rather than fight French warfare, are the committee
12:01
Speaker 1: through the balance of this year. Kevin is somebody who
12:05
Speaker 1: has said a lot of rude things about the FED recently.
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Speaker 1: He's also someone who has very high EQ and good
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Speaker 1: people management skills, and so I could imagine him behind
12:14
Speaker 1: closed doors actually being relatively conciliatory and try to build
12:19
Speaker 1: bridges with folks. But of course, if he comes in
12:22
Speaker 1: and says he's going to fire a third of the staff,
12:24
Speaker 1: for instance, as Mickey Bowman is doing on the banking side,
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Speaker 1: and has no interest in analytic traditional analytics around Ferbus
12:31
Speaker 1: and so forth, that would pit people's backs up and
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Speaker 1: make it less likely that they would follow him. Your
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Speaker 1: point is on the actual merits of the economic judgment.
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Speaker 1: I don't think people on the FED are going to
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Speaker 1: be willing to go with a positive productivity shock story
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Speaker 1: just on an assertion or on a belief or an
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Speaker 1: expectation that this is coming. At the same time, I
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Speaker 1: think we are already starting to see certain things in
12:56
Speaker 1: the data that starting to point in that direction. The
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Speaker 1: FED upgraded its productivity assessment for this year in December,
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Speaker 1: when Power essentially acknowledged that the base productivity growth has
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Speaker 1: already stepped up in the US. My own analysis suggests
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Speaker 1: that productivity this year next year will be again a
13:16
Speaker 1: bit higher than the last few years, which were a
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Speaker 1: bit higher than the years that went before them. And
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Speaker 1: so the question is what's the unbiased estimate. The unbiased estimate,
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Speaker 1: in other words, something which is equally likely to be
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Speaker 1: wrong on both sides probably does have a step up
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Speaker 1: in productivity. Just a question of how hard you want
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Speaker 1: to push that theme.
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Speaker 2: Yes, And I suspect that's something we'll be coming back
13:36
Speaker 2: to on trumponomics, not least because there are even some
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Speaker 2: small signs of a pickup in productivity in the UK,
13:42
Speaker 2: where it has been dead and varied for really a
13:44
Speaker 2: long time. So we were waiting to see if those
13:46
Speaker 2: get trampled on in the spring rains. Let's get to
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Speaker 2: his approach to the balance sheet, because where he has
13:52
Speaker 2: talked about really want to bring in the changes outside
13:57
Speaker 2: of the sort of traditional monetary policy, had you set
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Speaker 2: interest rate, is in this desire to shrink the balance sheet.
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Speaker 2: The Fed famously had its I think its balance sheet
14:08
Speaker 2: was less than a trillion dollars before the global financial crisis.
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Speaker 2: It peaked at about nine trillion dollars after COVID, and
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Speaker 2: it's shrunk a little bit as a result of those
14:18
Speaker 2: kind of those sales of bonds that the Fed was holding,
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Speaker 2: but it's still roughly seven or eight times what it
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Speaker 2: was twenty years ago. That potentially has quite big implications
14:29
Speaker 2: not for short term interest rates, but for long term
14:32
Speaker 2: interest rate if he aggressively moved to restart the shrinking
14:37
Speaker 2: of the Fed balance sheet, because obviously they had stopped
14:40
Speaker 2: that quite recently. So how do you see that and
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Speaker 2: are you concerned about it? Right?
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Speaker 1: Yeah, So, first of all, just for your listeners, it's
14:48
Speaker 1: made a bit more progress bringing down the balance sheet
14:51
Speaker 1: from the peak around I think, as you said, was
14:53
Speaker 1: it nine trillion. We're down about six and a half
14:55
Speaker 1: trillion at this point. That's an appreciable reduction, and in
14:59
Speaker 1: terms of the ratio of the central bank balance sheet
15:01
Speaker 1: to nominal GDP, which is or banking assets, which is
15:05
Speaker 1: a sort of a kind of reasonable benchmark. You certainly
15:08
Speaker 1: unwound the pandemic expansion in the balance sheet, so that
15:11
Speaker 1: past at least has roundtripped. But you're absolutely right that
15:16
Speaker 1: if we're looking for one consistent theme across Kevin Walsh's career,
15:20
Speaker 1: it's that he favors a smaller, cleaner, and I would
15:24
Speaker 1: add humbler central bank balance sheet, meaning that it's not
15:29
Speaker 1: just about the size and composition and duration of the
15:31
Speaker 1: balance sheet, but it's also about this idea that a
15:34
Speaker 1: big central bank balance sheet is a form of big
15:37
Speaker 1: government at big footprint of the government sector in markets,
15:42
Speaker 1: and that this is unhealthy in lots of ways, some
15:45
Speaker 1: of which relate to the encouragement it gives to the
15:48
Speaker 1: fiscal authority to run big deficits and debts, but also
15:52
Speaker 1: that just you don't want a system where the central
15:55
Speaker 1: bank is such a big actor in money markets and
15:58
Speaker 1: in financial markets. So I think that is a deep
16:02
Speaker 1: seated and sincere conviction on the part of Wash. The
16:06
Speaker 1: question is how should we expect that he will look
16:08
Speaker 1: to try to reflect that during his tenure as FAT chair.
16:12
Speaker 1: I think the idea that Kevin will go out there
16:14
Speaker 1: and try to kick off some big QT program fairly
16:17
Speaker 1: soon is laughably improbable. He is somebody who is quite
16:21
Speaker 1: savvy and understands full well that his greatest point of
16:25
Speaker 1: vulnerability is his past comments about the balance sheet. And
16:29
Speaker 1: if he says anything that sounds too hawkish on the
16:31
Speaker 1: balance sheet or suggests that he might be keen kick
16:34
Speaker 1: on with QT again fairly soon, he writ is to
16:37
Speaker 1: blow up in terms of a spike in bond yield.
16:40
Speaker 1: That would not only be a big hit to the
16:43
Speaker 1: start of his career as VET chair, he would also
16:46
Speaker 1: blow up his relationship with Secretary Vesant and President Trump.
16:50
Speaker 1: So this is the last thing that Kevin wants. I
16:52
Speaker 1: think Kevin will as soon as he starts speaking, he
16:55
Speaker 1: will signal that he's going to be very pragmatic on
16:58
Speaker 1: the balance sheet, very in terms of what he may
17:02
Speaker 1: try to do on the balance sheet. One mechanism for
17:06
Speaker 1: signaling that to the market is his idea of a
17:09
Speaker 1: Fed Treasury accord that would facilitate closer institutional cooperation between
17:15
Speaker 1: the Fed and the Treasury. Now the mention of Fed
17:17
Speaker 1: Treasury accords makes some as nervous as to exactly how
17:21
Speaker 1: this would affect contritionan traditional conceptions of central bank independence.
17:25
Speaker 1: But Kevin will argue that, look, the central Bank can
17:28
Speaker 1: be independent but still coordinate the more effective or cooperate
17:31
Speaker 1: in a more effective way with the Treasury in the
17:34
Speaker 1: here and now. That would be very much I think
17:36
Speaker 1: about making sure that any balance sheet plans on the
17:40
Speaker 1: Fed side were consistent with plans on the Treasury's debt
17:43
Speaker 1: management side, if you like a little bit of sort
17:46
Speaker 1: of soft coordination there. But I think the signal to
17:49
Speaker 1: market is intended to be that I Kevin Walsh and
17:53
Speaker 1: giving Scott Besson a soft veto, not a hard veto,
17:57
Speaker 1: but a soft veto on any QT plans. So you
18:01
Speaker 1: can all relax because you may not trust me, but
18:03
Speaker 1: you know full well that Scott doesn't want higher yields
18:06
Speaker 1: and higher mortgage rates.
18:25
Speaker 2: Just to get into that whether you because you are
18:27
Speaker 2: such a sort of long term observer and thinker about
18:30
Speaker 2: this particular bit of the market and the kind of
18:32
Speaker 2: interaction of markets with policy of the Fed, you could
18:36
Speaker 2: imagine quite a lot of people in the financial markets
18:39
Speaker 2: would think, yeah, big government's bad. We don't like FED
18:42
Speaker 2: that gets in the way and gets super involved in
18:44
Speaker 2: lots of different things. On the other hand, some of
18:47
Speaker 2: the people who have talked to me who've been most
18:50
Speaker 2: concerned about shrinking the FED balance sheet faster have been
18:54
Speaker 2: people who look at the short term liquidity of treasury
18:57
Speaker 2: markets and the repurchase market. That's kind of very short
19:00
Speaker 2: term equidity that banks need to keep the financial system
19:03
Speaker 2: ticking over, and a worried that if you have, over
19:06
Speaker 2: time quite a significant reduction in the balance sheet that
19:09
Speaker 2: could actually have unexpected consequences that we don't really understand
19:12
Speaker 2: for liquidity in day to day markets. Do you agree
19:15
Speaker 2: with that?
19:16
Speaker 1: I certainly think if it was mishandled, it would have
19:18
Speaker 1: very significant consequences for money markets as well as potentially
19:22
Speaker 1: the functioning of the treasure debt market itself. That's precisely
19:25
Speaker 1: why wash is going to be extremely careful here. So
19:28
Speaker 1: if you forgive me for just being a little bit
19:30
Speaker 1: analytic for a second step, Kevin understands full well that
19:35
Speaker 1: the size of the fair balance sheet is dictated by
19:41
Speaker 1: the amount of reserves that banks want to hold for
19:46
Speaker 1: any given chosen operating framework, that the Central Bank operates with.
19:54
Speaker 1: So the big change from the pre financial crisis period
19:58
Speaker 1: to the present is that the FED moved from what
20:01
Speaker 1: was called a scarce reserves system to what's called an
20:05
Speaker 1: ample reserves system. In theory, the WASHPED could try to
20:10
Speaker 1: overtime move back towards a scarce reserve system, that would
20:15
Speaker 1: be extremely difficult to implement operationally, very challenging. It would
20:21
Speaker 1: be a massive headache, and it would also involve the
20:24
Speaker 1: kind of FED portfolio shrinkage over time that would likely
20:28
Speaker 1: put substantial upward pressure on longer term bond yields in
20:33
Speaker 1: a way that would be very much antithetical to what
20:36
Speaker 1: the Treasury and the White House is trying to achieve.
20:39
Speaker 1: We think that the FED itself would not go along
20:42
Speaker 1: with that, that the vast majority of the FOMC has
20:47
Speaker 1: a sort of settled preference for the ample reserves system.
20:52
Speaker 1: So our call is that WASH will not move off
20:55
Speaker 1: the ample reserve system towards the scarce reserve system. Once
20:59
Speaker 1: you've settled that you're running an ample reserve system, you're
21:01
Speaker 1: going to have a big balance sheet period. Now question
21:05
Speaker 1: how big. Let's determine by the second part of the
21:08
Speaker 1: formula I gave you how many reserves do the banks
21:11
Speaker 1: want to hold for a given operating framework. Now that
21:16
Speaker 1: may be sensitive to the regulatory regime. What I think
21:21
Speaker 1: is potentially going to happen here is that Wash, in
21:25
Speaker 1: concert with the Treasury and the other banking regulatory agencies
21:29
Speaker 1: in the US, will be pushing hard on banking deregulation.
21:34
Speaker 1: The FAD will also, Underwash, be pushing hard on easing
21:38
Speaker 1: up on banking supervision, which is the sort of the
21:41
Speaker 1: implementation of the rules, if you like, rather than the
21:43
Speaker 1: rules themselves. And the hope would be that as a
21:49
Speaker 1: result of extensive banking deregulation that makes it cheaper in
21:54
Speaker 1: capital terms and liquidity terms to hold government paper, banks
22:00
Speaker 1: will choose to hold a bit more government debt, including
22:04
Speaker 1: treasury bills, and a bit less by way of bed reserves,
22:09
Speaker 1: to the extent that banking deregulation means that the bank's
22:14
Speaker 1: desire less reserves. That would then allow Kevin to reduce
22:19
Speaker 1: the balance sheet some without stressing money markets. But if
22:23
Speaker 1: he tried to reduce the balance sheet today without changing
22:28
Speaker 1: the framework or banks demand for reserves in the framework,
22:32
Speaker 1: all that would happen is you would have an immediate
22:35
Speaker 1: return to money market stress of the kind we saw
22:37
Speaker 1: in October and December, and he'd be back in balance
22:40
Speaker 1: sheet expansion again within a week. He knows that, and
22:43
Speaker 1: that's why it's not going to happen.
22:45
Speaker 2: You're always very measured in what you say, Krishna, but
22:47
Speaker 2: you seem pretty relaxed about a wash FED. We talked
22:52
Speaker 2: about the interest rates. Certainly he doesn't have an outlandish
22:54
Speaker 2: approach to setting interest rates. And on this question of
22:58
Speaker 2: better coordination with the Treasury or kind of soft coordination
23:04
Speaker 2: with the Treasury over balance sheet policy, lot of economists
23:08
Speaker 2: have pointed to the possibility that if you have super
23:10
Speaker 2: independent fiscal policy and monetary policy in an environment of
23:14
Speaker 2: a big FED balance sheet, then you have got quite
23:16
Speaker 2: a strong possibility of one arm of policy getting in
23:18
Speaker 2: the way of the other. So it doesn't seem crazy
23:21
Speaker 2: to have a degree of coordination. I guess the question
23:23
Speaker 2: is do we have good coordination joined up policy versus
23:27
Speaker 2: bad coordination, which is Trump going on true social and
23:30
Speaker 2: demanding interest rate cuts. But you seem to think the
23:32
Speaker 2: bats is going to be a healthy one.
23:34
Speaker 1: I guess the way I would put in is that
23:37
Speaker 1: I think that the crude version of concerns about Wash,
23:40
Speaker 1: which is he's super hawkish on inflation and interest rates,
23:43
Speaker 1: and he's super hawkish on QT just don't bear particularly
23:47
Speaker 1: close examination, certainly not in the here and now context.
23:51
Speaker 1: That's not what we should be worrying about. That doesn't
23:54
Speaker 1: mean that there are no points of vulnerability or things
23:58
Speaker 1: that we should be attended to in the case of
24:00
Speaker 1: a Wash FED. As I indicated earlier on monetary policy,
24:04
Speaker 1: I think the question is it's fine, and indeed, I
24:07
Speaker 1: think very legitimate to critique some of the shortcomings of
24:10
Speaker 1: traditional FED models and backward looking data dependence, but it's
24:14
Speaker 1: going to be very hard to replace that with something
24:17
Speaker 1: that is coherent and systematic and well communicated, and that
24:23
Speaker 1: could go badly wrong if Wash were to turn his
24:26
Speaker 1: back on the old ways of doing business without having
24:29
Speaker 1: figured out a fully coherent set of approach or set
24:32
Speaker 1: of approaches to replace it. With respect to the balance sheet,
24:36
Speaker 1: I think Wash is going to be much more careful
24:39
Speaker 1: than many think. Nonetheless, though we are already paying the
24:42
Speaker 1: price today in markets for Kevin's past comments on the
24:47
Speaker 1: balance sheet and the uncertainty that this is created about.
24:51
Speaker 1: If you like the Fed's balance sheet reaction, function in
24:55
Speaker 1: a wash error, and having lived through the Taper ten
25:00
Speaker 1: at the New York FED, where I was a senior advisor,
25:04
Speaker 1: I will tell you that I at least have always
25:06
Speaker 1: taken away from that episode how potentially dangerous it can
25:10
Speaker 1: be for central banks to try to reset market expectations
25:14
Speaker 1: as to the approach that they're going to take to
25:17
Speaker 1: their balance sheets going forward. Now, I'm absolutely not predicting
25:20
Speaker 1: a wash taper tantrum, but I am saying that he
25:25
Speaker 1: has is going to have to move very carefully to
25:28
Speaker 1: update and clarify markets and guide markets as to his
25:33
Speaker 1: thinking on the balance sheet himself. And then separately, as
25:38
Speaker 1: you suggested, a Fed Treasury accord has potentially some upsides
25:45
Speaker 1: and potentially some can very concerning downsides, And the devil
25:49
Speaker 1: really would be in the detail as to whether this
25:53
Speaker 1: was a sensible vehicle for a cooperation starting from the
25:58
Speaker 1: principle of very firm and dependence on the side of
26:01
Speaker 1: the central bank but looking to cooperate where appropriate to
26:05
Speaker 1: implement policy, or whether this would be a vehicle for
26:09
Speaker 1: some erosion of that central bank's independence. The bond market
26:13
Speaker 1: certainly will will be wary until we find out exactly
26:17
Speaker 1: which type.
26:18
Speaker 2: It is at some level, all of this is irrelevant
26:21
Speaker 2: if he doesn't bring a majority of his colleagues on side,
26:24
Speaker 2: at least to some degree. You talked about we're already
26:27
Speaker 2: paying the price in the markets. He's paying the price
26:29
Speaker 2: not just for former comments about the balance sheet, but
26:31
Speaker 2: the fact that he has been chosen by Donald Trump
26:34
Speaker 2: in a very politicized environment where a lot was said
26:37
Speaker 2: about the need to lower interest rates and etc. Etc. So,
26:40
Speaker 2: as you said, he has a repair job to do.
26:42
Speaker 2: Everything that we've read about him, we had a very
26:44
Speaker 2: good profile. The politico had a very good profile. He
26:46
Speaker 2: seems to be not someone who would go in as
26:49
Speaker 2: a bull in a china shop. He seems, from a
26:50
Speaker 2: young age, has shown a very good networking ability and
26:53
Speaker 2: ability to win people over. Do you think you're going
26:56
Speaker 2: to see what a lot of people are expecting, which
26:58
Speaker 2: is very split boats relative to the past on the FMC,
27:03
Speaker 2: And do you think j. Powell's going to stick around,
27:06
Speaker 2: which will also make it slightly more difficult for him.
27:08
Speaker 1: Let me take that in reverse order. First of all,
27:10
Speaker 1: I think the recent month's escalation of Trump attacks administration
27:16
Speaker 1: attacks on the FED culminating in the issuance of the
27:19
Speaker 1: DOJ subpoenas against Powell have made it a lot more
27:22
Speaker 1: likely that Powell will stay on. I don't think he
27:24
Speaker 1: was actually intending to stay on beyond May. I think
27:26
Speaker 1: it's made him more likely than he will. With that said,
27:29
Speaker 1: and certainly I don't think he can possibly step down
27:32
Speaker 1: Powell at a minimum unless the DOJ investigation is closed
27:36
Speaker 1: down beforehand, because he can't look like he's leaving under pressure.
27:40
Speaker 1: With that said, I think, and the appointment of Kevin
27:43
Speaker 1: Wah she was somebody who has long been regarded as
27:45
Speaker 1: a legitimate candidate to run the Central Bank makes it
27:49
Speaker 1: harder for Powell to justify staying on for some extended
27:52
Speaker 1: period of time than would have been the case if
27:55
Speaker 1: Trump had appointed one of his own advisors, for instance,
27:58
Speaker 1: like Kevin Hassett into that seat. With respect to the Committee,
28:03
Speaker 1: there is a lot of folks in the market seem
28:05
Speaker 1: to think that the FED is going to become the
28:08
Speaker 1: Bank of England and everything's going to be decided on
28:12
Speaker 1: the FED equivalent of a five to four votes and
28:14
Speaker 1: does the governor Does the governor not have the fifth
28:16
Speaker 1: vote he needs, It's not inconceivable. That's where it ends
28:21
Speaker 1: up but it's not the base case. The base case
28:23
Speaker 1: is still that the FED will make policy the way
28:26
Speaker 1: the FED has always made policy, which is through a
28:28
Speaker 1: structured negotiation between the chairman and his senior allies. Typically
28:34
Speaker 1: the troika figures the New York FED President and the
28:36
Speaker 1: vice chair a structured negotiation between that leadership group and
28:39
Speaker 1: the wider committee. That negotiation will be a lot more
28:43
Speaker 1: stressed this year for all the reasons that you articulate,
28:47
Speaker 1: but I still think of it as operating by way
28:49
Speaker 1: of that structured negotiation. Within that, it matters he has
28:54
Speaker 1: the leverage. So the more allies WASH has on the
28:58
Speaker 1: FED board, more seats that are vacated, allowing Trump to
29:02
Speaker 1: point to new officials, it increases its leverage within that negotiation.
29:07
Speaker 1: But I think the odds are still that what we
29:10
Speaker 1: get is predominantly a negotiated outcome rather than a drum
29:15
Speaker 1: roll and drama as to which way the vote is
29:17
Speaker 1: going to break on a given day.
29:20
Speaker 2: And of course, the crucial difference between the Bank of
29:22
Speaker 2: England and the Fed is FED the German votes first,
29:27
Speaker 2: and that the Bank of England the governor votes last.
29:30
Speaker 1: In almost every case, the decision has essentially been arrived
29:34
Speaker 1: at by the time they sit down at the table.
29:37
Speaker 1: And the reason it's been arrived at is because, again,
29:40
Speaker 1: the way the FED makes decisions is through a chair
29:44
Speaker 1: led effort to craft a central view that the vast
29:48
Speaker 1: majority of people can sign up to, even if it's
29:51
Speaker 1: not their very first best preference, for whatever it's worth.
29:56
Speaker 1: I actually think that is a superior way to run
29:59
Speaker 1: a central bank. I don't believe that a central bank
30:02
Speaker 1: can actually operate with nine or in the Fed's case,
30:05
Speaker 1: nineteen different reaction functions. I think it has to have
30:09
Speaker 1: a reaction function, and that means something that's crafted, a
30:13
Speaker 1: central view that's crafted. So that's where I think WASH
30:16
Speaker 1: will try to go. I do think that the Old
30:19
Speaker 1: Committee will try to meet him halfway, but the extent
30:23
Speaker 1: to which that's possible will depend both on economic conditions,
30:27
Speaker 1: whether they give the Old Committee the slack to meet
30:31
Speaker 1: Wash halfway in terms of inflation risks and labor market pressures,
30:35
Speaker 1: and it will depend on WASH's own conduct and the
30:39
Speaker 1: conduct of Trump relative to the Fed. I think the
30:42
Speaker 1: hope is that we can preserve some version of the
30:44
Speaker 1: old way of making policy, but it is going to
30:48
Speaker 1: be under unique stress this year.
30:53
Speaker 2: Crystal clear as always and extremely useful and interesting.
30:57
Speaker 1: Thank you so much, he's supposed to have always fun
30:59
Speaker 1: to do it with.
31:00
Speaker 2: Thanks for listening to Trumpnomics from Bloomberg. It was hosted
31:05
Speaker 2: by Me, Stephanie Flanders and I was joined by Krishna Guha.
31:09
Speaker 2: Trumponomics was produced by Samasadi and Moss, and sound design
31:13
Speaker 2: was by Blake Maples and Aaron Casper. To help others
31:16
Speaker 2: find the show, please rate and review it highly wherever
31:19
Speaker 2: you listen