Warsh’s Position Is Untenable Already

Kevin Warsh is between a rock and a hard place.

I’d say I feel bad for him, but I don’t. Warsh knew what he was getting into when he took a job no one who cared about their sanity — and no one possessed of any integrity, I should add — would accept.

Not even six months into the Fed chair role, Warsh faces an impossible choice:

1. Raise rates quickly to shore up his own credibility as an inflation fighter, knowing full well that rate hikes can’t address supply shocks unless they’re draconian enough to reverse the vaunted “wealth effect” and brake consumption economy-wide, or
2. Slow-walk rate hikes and risk being viewed as a partisan shill who’s “all hat, no cattle” when it comes to bold promises about corralling inflation

That’s a Sophie’s Choice. Option one runs the very real risk of tightening the US economy into a sharp slowdown because, if we’re honest, the situation’s probably more fragile than the jobs and spending aggregates suggest. Hiking aggressively when Americans are paying $5 at the pump and mortgage rates are rising sharply will seem cruel, and Donald Trump would be keen to exacerbate the situation by accusing Warsh of harming American families.

Option two carries existential risks. Not delivering on rate hikes that are priced by the market as near certainties is to chance a runaway bear steepener as traders fret about Fed independence and the read-across for inflation.

Make no mistake: This is Trump’s fault. If it weren’t for the tariffs and the war, the market wouldn’t be pricing a succession of Fed hikes in the first place. And that’s just like Trump, isn’t it? Put someone (in this case Warsh) in a position (in this case Fed chair) and immediately make that position untenable by creating the conditions whereby staying in the good graces of the executive entails subjugating America’s long-term prosperity to short-term political expediency.

The figure above’s as simple as market charts get: It’s just the 2s10s. As noted, that all important spread shrank inside 20bps last week.

That encapsulates Warsh’s dilemma: A 2s10s inversion, should it come to that, would augur a recession, and while Warsh can perhaps point to the flattener as evidence to support a cautious approach to hikes, that’ll be a tough sell in the context of lingering questions about his bona fides.

At the highs last week, twos were nearly 110bps wide to EFFR — four “hikes,” plus some — the same as before the September rate hike. On Monday morning, the gap was 104bps.

If Warsh doesn’t intend to deliver anything like the medium-term tightening implied by that yawning disparity, he needs to communicate that to STIRs. Otherwise, he’s creating an extremely combustible situation on the excuse that forward guidance is injurious to markets.

The longer the war drags on, the more untenable Warsh’s position will be. There are no good options, and the honeymoon period during which he was granted some leeway by Scott Bessent and Trump to talk tough on inflation is likely over.

Let me put this as a question: How many rate hikes can we realistically expect Trump to countenance before he starts alluding to Warsh’s removal or, more likely, renews his assault on Jerome Powell and Lisa Cook in a bid to free up two board seats?

Meanwhile, Bessent hired David Zervos to serve in what’s being described as a “broad advisory capacity” at Treasury. He starts “immediately.”