Warsh, Trump's Next 'Scapegoat' at the Fed?

Original Author: Zhang Yaqi

Original Source: Wall Street News

Warsh is about to face the long-awaited Federal Reserve Chairman confirmation hearing. This moment is fraught with undercurrents: he must show a posture of compliance to Trump while holding the central bank's line against inflationary pressures. Any misstep could make him the next scapegoat for White House accountability.

The Senate Banking Committee is scheduled to begin confirmation hearings for Warsh this Tuesday. According to the Financial Times citing multiple sources familiar with the matter, the 56-year-old nominee has envisioned a series of reforms: from reducing the frequency of the Fed's communications to shrinking its balance sheet, which exceeds $6.7 trillion. However, futures markets currently indicate less than a 50% probability of a 25 basis point rate cut this year—far from meeting Trump's repeated calls on his Truth Social platform for "significant" and "immediate" rate cuts.

Derek Tang of Monetary Policy Analytics warned, "For Warsh, the honeymoon period could be very short." This hints at an awkward predicament: if Warsh fails to meet Trump's demands for rate cuts, he is likely to become a target of public attacks from the President, much like his predecessor Powell—only this time, the "scapegoat" role shifts from being called a "fool" to being accused of "betrayal."

Meanwhile, the confirmation process itself faces significant hurdles: Republican Senator Thom Tillis has threatened to block the nomination from reaching a full Senate vote. Current Chairman Powell's term expires on May 15th, and Trump warned last week that he would fire Powell if he fails to leave "on time."

For the markets, the core uncertainty lies in: Can Warsh find a path between Trump's political pressure and the Federal Reserve's institutional credibility? Several former Fed officials warn that history provides a precedent—in the 1970s, Fed Chairman Arthur Burns yielded to Nixon's demands for rate cuts, ultimately leading to years of stagflation and leaving behind the historical verdict of being a "scapegoat."

In other words, whether Warsh chooses compliance or defiance, he could become a scapegoat: compliance risks repeating Burns' mistake, bearing the blame for runaway inflation; defiance risks following in Powell's footsteps, becoming the next target of Trump's political wrath.

"The Reformer" – Warsh Aims to Shake the Fed's "Foundations"

Warsh has long coveted the position of Federal Reserve Chairman. Eight years ago, he lost to Powell. After Trump's recent election victory, he was offered the position of Treasury Secretary, but he made it clear that leading the central bank was his true ambition.

In terms of policy stance, Warsh's reform agenda is quite radical. He is deeply dissatisfied with the Fed's current communication system, particularly disliking the so-called "dot plot"—the chart published quarterly, providing anonymous interest rate forecasts from 19 officials. In a speech a year ago, he warned, "Once policymakers publish economic forecasts, they may become prisoners of their own words."

Beyond reducing public statements, Warsh also hopes to lead by example, encouraging other officials to lower their media exposure frequency. Vincent Reinhart, Chief Economist at BNY Investments and a former senior Fed official, interpreted: "Warsh's rationale for narrowing communication is that if actions are consistent enough, there's no need to speak constantly. He also believes excessive communication creates risks of over-promising and makes the committee more vulnerable to political criticism."

On the balance sheet issue, Warsh hopes to shrink the sheet, which has ballooned to $6.7 trillion due to large-scale asset purchases during the financial crisis and the COVID-19 pandemic. According to media reports citing sources familiar with the matter, his envisioned path for balance sheet reduction would be gradual, not seeking to return to pre-2008 levels, and would require extensive preliminary research. His core logic is: by contracting liquidity in the banking system to tighten financial conditions, creating room to cut short-term interest rates.

However, Joseph Gagnon, a former Fed official now at the Peterson Institute for International Economics, points out an inherent contradiction: "He tells Trump that through balance sheet policy, he can cut rates significantly. But I suspect he hasn't told Trump that this might actually mean higher mortgage rates, not lower." Currently, Chris Waller, one of the most respected economists on the Fed's Board, has explicitly rejected the idea of shrinking the balance sheet to pre-crisis levels, calling it "inefficient" and "stupid" as it could trigger market turmoil.

Shifting Stances, Is He Credible?

During his undergraduate studies at Stanford University, Warsh studied under the monetarist master Milton Friedman and claims to have been deeply influenced by him. In 2006, he joined the central bank as the youngest governor in Fed history and served as a crucial link between then-Chairman Ben Bernanke, Wall Street, and Congress during the financial crisis. Days before Lehman Brothers collapsed, he had already warned about inflationary pressures, representing the hawkish faction within the committee at that time.

However, during Trump's current term, when the President publicly called Powell a "fool" and an "idiot" to pressure for rate cuts, Warsh displayed a more dovish stance. Citing an argument adapted from former Chairman Alan Greenspan, he argued that an AI-driven productivity boom would pave the way for significant rate cuts—a view questioned by several FOMC members.

Alan Schwartz, who worked with Warsh at Bear Stearns, believes Warsh's decisions will be based on economic data, not White House pressure: "If the facts change, Warsh won't stick to dogma. He has an excellent reputation in financial policy and will strive to find the right answer." Schwartz of Guggenheim Partners added that this also means his stance may adjust with changing circumstances.

Raghuram Rajan, former Governor of the Reserve Bank of India and a scholar at the University of Chicago, cautions that Warsh will take office under "enormous political constraints," and potential risks in private credit markets may require him to address financial stability issues in addition to monetary policy challenges.

Trump and Wall Street: Neither Side is Easy to Handle

Warsh was not Trump's first choice. According to the Financial Times, Trump has long told his inner circle that he preferred to nominate National Economic Council Director Kevin Hassett. However, Hassett's candidacy sparked strong backlash on Wall Street—there was deep concern over his absolute obedience to Trump on issues like tariffs and firing the head of the Bureau of Labor Statistics.

The turning point came when Trump ally and Washington D.C. federal prosecutor Jeanine Pirro launched a criminal investigation into Powell. Powell immediately fought back publicly, calling the investigation a ploy to force the Fed to cut rates, making Wall Street clearly see the risks of having a "Trump yes-man" as central bank chief. Financial heavyweights like JPMorgan Chase CEO Jamie Dimon privately pressured Trump to choose another candidate, ultimately leading to Warsh's nomination.

Warsh is not entirely without connections to Trump's circle—he is the son-in-law of Republican donor and Trump's university classmate Ronald Lauder. He also knows Treasury Secretary Bessent from their time at the family office of Wall Street titan Stanley Druckenmiller, and Bessent was a key figure in the initial nomination interview process.

Senate Confirmation: Fellow Republicans Pose the First Hurdle

Warsh's confirmation process faces substantial obstacles. North Carolina Republican Senator Thom Tillis has explicitly stated he will block Warsh's nomination from reaching a full Senate vote until the criminal investigation into Powell is dropped. This deadlock raises the possibility that Powell may remain in office after his term expires on May 15th.

In response, Trump warned last Wednesday that he would fire Powell if he does not leave "on time," while also expressing continued support for Pirro to proceed with the investigation. Powell stated he would stay on as acting chairman until Warsh secures majority support in the Senate.

Without the support of at least 51 of the 53 Republican senators, Warsh's path to becoming Fed Chairman faces failure. However, once the investigation into Powell is resolved, the prevailing judgment in political circles and prediction markets is that the Republican Senate will ultimately not block Warsh from assuming the position he has long coveted.

Some observers even believe that delays in the confirmation process might not be entirely unfavorable for Warsh. If courts rule favorably in lawsuits related to Cook and Powell, it could not only unblock the confirmation process but also provide institutional protection for Warsh against White House pressure. Gagnon stated bluntly:

"I believe whatever Warsh may have told Trump, he doesn't want to become the next Arthur Burns, the one who yielded to Nixon's will and ultimately ignited years of stagflation. If the Supreme Court protects Lisa Cook's position, Warsh would likely receive similar protection. Then he would think he can do the right thing—and what he thinks is right is likely to disappoint Trump."