Ok, so thankfully the Fed Chair isn’t going to stand trial.
I hate government waste as much as the next guy ($2.5 billion for a renovation is ridiculous) but court proceedings against Powell would have destabilized capital markets.
As my teenage son would say, they are really ‘glazing’ this new building. If you know, you know.
So the Fed gets to keep the “gold-plated toilets” in their new building and we get Kevin Warsh, who now has a path to Fed Chair confirmation.
I actually think this is a great trade.
Why is this good news for Evergreen and its clients / investors?
Because Warsh is a breath of fresh air.
He wants the Fed to be far less vocal and reduce it’s influence on financial markets.
The Fed should become quieter and less of a crutch.
For the last 15 years, markets have been driven as much by Fed signaling and liquidity as by market fundamentals. Quantitative easing and the “Fed put” pushed investors out the risk curve and distorted pricing across assets.
Warsh is critical of that approach.
Less intervention means fewer artificial tailwinds for “growth at all costs” assets and more focus on real cash flows.
Higher for longer rates and less Fed support tends to favor income, debt, and asset-backed strategies over speculative growth.
In other words, a shift away from liquidity-driven markets and toward cash flow-driven returns.
Furthermore, he’s not dogmatic about blindly following inflation data. The Fed has been late both tightening and easing rates due to lagging inflation numbers. This is especially true of shelter costs which is still adding upward pressure to CPI despite rents being down or flat for a while now.
In other words, the Fed is usually fighting the last war.
To be clear, I don’t forecast markets, inflation or interest rates. If someone tells you now is a great time to invest because interest rates are “definitely going lower”, they’ve outed themselves as an amateur investor. Professional investors have seen too much. They know these things can flip on a dime.
So I try to avoid predictions. Instead, I handicap.
My grandfather would be happy to hear me admit that. You see, he was quite fond of betting the ponies.
Now, my passion is income investments vs. Del Mar Race Track, but at the end of the day, great investing is great handicapping.
Therefore, the investor’s job is figuring out:
A) the odds of success and…
B) whether we’re getting paid enough to take that risk?
It’s not to forecast rates or obsess about the Fed.
However, we do focus on income investments so…kinda important to follow base rates.
Because the Fed funds rate is financial gravity, it’s the metric professional investors use to calibrate all new investment decisions.
What changes will this Fed Chair likely pursue?
He wants to lower short-term rates a bit (but not dramatically and never back to zero) to steepen the yield curve.
He wants mortgage backed securities (MBS) off the Fed’s balance sheet, which could put upward pressure on 30 year bond yields over time.
He believes AI is likely disinflationary. Productivity gains from AI should act as a governor on prices. Lower input costs, faster output, less labor-intensive growth. This would give the Fed cover to lower rates incrementally and let inflation “run a bit hot”.
What does this mean for income investors?
If short-term rates move lower from here you probably won’t want to hold as much cash / t-bills, which are increasingly vulnerable to inflation.
Deep down Warsh is a bit of a hawk (not a traditional dove).
He seems to have an interest rate floor he’s not going under and he’d like to reduce the Fed’s balance sheet.
So while short term rates may move lower, the “Fed Put” and growth-at-all-costs era is likely behind us. If longer term rates remain elevated, hard, cash flowing assets that can outpace inflation seem well positioned for a Kevin Warsh-led Federal Reserve.
Brad Johnson