Warsh's regime change at the Fed pushes ahead – and meets resistance

• Markets expect additional rate hikes, with the 2-year Treasury yield trading nearly a full percentage point above the federal funds rate, the largest spread since 2023, as inflation has exceeded the Fed's 2% target for over 5.5 years
• Warsh's new framework emphasizes 'financial conditions' including asset prices, credit availability, commodity prices (up 30% this year), and the dollar's value, marking a sharp departure from predecessor frameworks focused on whether rates were 'accommodative, neutral or restrictive'
• Balance sheet reduction plans remain stalled as other FOMC members resist quick action and the 10-year Treasury yield above 5% makes it inopportune to add supply to markets, with task forces expected to report early next year

Summary: Warsh's Fed Reform Efforts Face Challenges

Fed Chairman Kevin Warsh is implementing significant changes to the Federal Reserve 127 days into his tenure, though larger reforms are progressing slowly due to economic constraints and institutional resistance.

Key Changes Implemented

Warsh has abandoned traditional forward guidance and reframed the Fed's communication approach. He dismissed the conventional "neutral rate" framework as merely "useful academically," instead emphasizing a broader assessment of financial conditions that includes asset prices, Treasury trading volumes, dollar value, credit availability, and commodity prices. This approach resembles former Chair Alan Greenspan's data-intensive methodology.

Recent Policy Actions

The Fed raised rates by a quarter-point last week—the first increase since 2023—with markets pricing in two additional hikes through March. The 2-year Treasury traded nearly a full percentage point above the federal funds rate, the largest spread since 2023, signaling market expectations for further tightening.

Inflation remains elevated at 3.7% (July PCE reading), above the Fed's 2% target for over 5½ years. Commodity prices have surged, with a broad index up 30% this year and heating oil rising 83%.

Obstacles to Reform

Warsh's priority to shrink the Fed's $6.7 trillion balance sheet faces delays. He appointed five task forces to examine Fed practices, with reports expected early next year. FOMC members remain reluctant to act quickly on balance sheet reduction, preferring consensus. Rising 10-year Treasury yields above 5% make this an inopportune time for Fed asset sales.

Critics, including economist Claudia Sahm, question Warsh's policy consistency, particularly his rejection of accommodation concepts while framing decisions as "removing accommodation."