Will Kevin Warsh resist Donald Trump’s pressure to drastically cut interest rates? You could conclude this from the market reaction to President Trump’s nomination last Friday of Warsh as head of the US central bank. And yet: no one knows exactly what interest rate policy Warsh will pursue.
After Trump’s choice of the experienced Warsh, who previously served as director of the Federal Reserve, the prices of gold and silver – traditionally ‘safe havens’ for investors – plunged heavily into the red on Friday and Monday. The exchange rate of the US dollar actually rose slightly.
Also read Kevin Warsh’s profile
Not a Trump puppet, but a monetary ‘hawk’: Kevin Warsh becomes the new head of the Fed
That was a break from recent weeks, when investors had dumped dollars and purchased large amounts of gold and silver because of the risk of inflation and financial instability under the Trump administration. This increases the national debt and puts heavy pressure on the Fed to lower interest rates, despite the fact that inflation in the US is high (about 3 percent instead of the 2 percent desired by the Fed).
With Warsh at the helm of the US central bank, the gold and silver markets now estimate that the risk of financial damage in the US is somewhat smaller. When Warsh (55) previously served on the Fed board, from 2006 to 2011, he was considered a monetary ‘hawk’. That is, as someone who instinctively prefers to keep interest rates high rather than low. Trump has put heavy pressure on Jerome Powell (Fed Chairman until mid-May) to lower interest rates.
On Monday afternoon, the gold price was almost 13 percent lower than Friday morning, the silver price was even almost 30 percent lower, so that gold is now more than 4,700 dollars per month. troy ounce (31.1 grams) costs, silver $82 per troy ounce. These are very significant price drops, but you have to keep in mind that the gold price is still barely 70 percent higher than a year ago, the silver price is even 150 percent higher. After the ‘Warsh effect’ – which is therefore limited – gold and silver prices are roughly at the level of the middle of last month.
Many got the wrong impression last week that Warsh will be a hawk. He can’t be and he won’t be
Speculation
The recent price increases of gold and silver and the downward correction around the weekend are largely the result of speculation, analysts say to the Reuters news agency. Many investors had gambled in futures contracts on further increases in the value of gold and silver in recent weeks and months. This further drove up the price on the ‘real’ market for the metals. The opposite happened on Friday and Monday: losses on the futures market reinforced the declines on the daily market.
The fact that many investors have recently invested in gold and silver (and in the Swiss franc, for example) and sold dollars is known as debasing trade. In other words, the ‘currency devaluation’ trade, which is about eroding confidence in the dollar. Whether this trade is completely over remains to be seen.
Robin Brooks, economist at the Brookings Institute think tank, points out in his newsletter that the market reaction to Warsh’s nomination is not clear. According to Brooks, you can conclude from some market indicators that (some) investors do expect low Fed rates under Warsh. For example, market interest rates on US government bonds with a short term of two years have fallen since Friday. This includes a market expectation of falling Fed rates.
Brooks doesn’t find it surprising. “Many got the wrong impression last week that Warsh will be a hawk. He cannot be and he will not be,” the economist wrote. “His worst nightmare is that Trump will turn on him, as he did with Powell.” Powell is regularly publicly attacked by Trump for his refusal to lower interest rates more quickly. The Fed chief recently received a subpoena in the central bank’s mailbox – an unprecedented action by the US justice department, which is widely interpreted as political interference in the Fed.
Artificial intelligence
Analysts and economists have varying estimates of Warsh. His reputation as a ‘hawk’ is mainly based on his criticism during his previous Fed administration of ‘quantitative easing’, the central bank’s large-scale purchase of government bonds and mortgage loans. The Fed, like other central banks, did this with the aim of pushing down long-term interest rates and thus boosting the economy after the 2008 financial crisis. Warsh described quantitative easing, an instrument that was used again during the pandemic, as market disruptive. He still believes that the Fed’s balance sheet, which has grown enormously due to this purchasing policy, should be reduced. This would increase long-term interest rates on the capital markets.
On the other hand, Warsh has been in favor of lowering the short-term interest rate set by the Fed in recent months. Like other economists around Trump, including current Fed director Stephen Miran, Warsh believes lower Fed rates are necessary because he is convinced that inflation will decline. He bases this, among other things, on an inflation-reducing effect that he expects from AI: it will make people more productive, which will reduce labor costs, which should have a downward effect on inflation as a whole. Warsh and Miran also think that inflation will fall due to Trump II’s deregulation agenda, which should be beneficial for companies. It’s all music to the ears of Trump, who is fixated on low interest rates.
Warsh: a monetary ‘hawk’ or a monetary ‘dove’? In his newsletter, economist Paul Krugman calls Warsh primarily an opportunist, a “political weather vane” who is a hawk when the Democrats are in power and then turns out to be a dove when the Republicans are in power.
If the Senate approves his nomination, Warsh will take over from Powell on May 15. Whether Trump named a hawk, dove or weather vane on Friday will only become clear afterwards.
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