Welcome to Thoughts on the Market.
I'm Matthew Hornbach, Global Head of Macro Strategy.
And I'm Michael Gapin, Morgan Stanley's Chief U.S.
Economist.
Today we'll be talking about the Federal Open Market Committee meeting that occurred last week.
It's Thursday, February 5th at 8.30 a.m. in New York.
So, Mike, last week we had the first Federal Open Market Committee meeting of 2026.
What were your general impressions from the meeting and how did it compare to what you had thought going in?
Well, Matt, I think that the main question for markets was –
How hawkish a hold or how dovish a hold would this be?
As you know, it was widely expected the Fed would be on hold.
The incoming data had been fairly solid.
Inflation wasn't all that concerning.
And most of the employment data suggested things had stabilized.
So it was clear they were going to pause.
The question was, would they pause or would they be on pause?
And in our view, it was more of a dovish hold.
And by that it suggests to us or they suggested to us.
I should say that they still have an easing bias and rates should generally move lower.
So that really was the key takeaway for me.
Would they signal a prolonged pause and perhaps suggest that they might be done with the easing cycle?
Or would they say yes, we've stopped for now, but we still expect to cut rates later, perhaps when inflation comes down, and therefore kind of retain a dovish bias or an easing bias in the policy rate path?
So to me, that was the main takeaway.
Okay.
Of course, as we all know, there are supposed to be some personnel changes on the committee this year.
And Chair Powell was asked several questions to try to get at the future of this committee and what he himself was going to do personally.
What was your impression of his response?
And what were the takeaways from that part of the press conference?
Well, clearly he's been reluctant to say preannounce what he may do when his term as chair ends in May.
But his term as a governor extends into 2028.
So he has options.
He could leave.
Normally that's what happens.
But he could also stay.
Yeah.
And he's never really made his intentions clear on that part, I think for maybe personal or professional reasons.
But he has his own reasons, and that's fine.
And I do think the recent subpoena by the DOJ has changed the calculus in that.
At least my own view is that it makes it more likely that he stays around.
It may be easier for him – to act in response to that subpoena by being on staff.
It's a request for additional information.
He needs access to that information.
I think you could construct a reasonable scenario under which well, I have to see this through, therefore I may stay around.
But maybe he hasn't come to that conclusion yet.
And then stepping back.
It just complicates the whole picture, in the sense that we now know the administration has put forward Kevin Warsh as the new Fed chair, and Will he be replacing the seat that Jay Powell currently sits in?
Will he be replacing the seat that Stephen Myron is sitting in?
So yes, we have a new name being put forward, but it's not exactly clear where that slot will be and what the composition of the committee will look like.
Well, you beat me to the punch on mentioning Kevin Warsh.
I kind of assumed that's where you were going.
That's going to be my next question.
I'm curious as to what you think that means for Fed policy later this year, if anything, and what it might mean more medium term.
First of all, congratulations to Mr. Warsh on the appointment.
In terms of what we think it means for the outlook for the Fed's reaction function and interest rate policy, we doubt that there will be a material change in the Fed's reaction function.
His previous public remarks don't suggest his views on interest rate policy are substantively outside the mainstream, or at least certainly the collective that's already in the FOMC.
Some people would prefer not to ease.
The majority of the committee still sees a couple more rate cuts ahead of them.
Warsh is generally aligned with that, given his public remarks.
But then also...
All the Reserve Bank presidents have been renominated.
There's an ongoing Supreme Court case about the ability of the administration to fire Lisa Cook.
If that is not successful, then Kevin Warsh will arrive in an FOMC where there's 16 other people who all get a say.
So the chair's primary responsibility is to build a consensus to herd the cats, so to speak, to communicate to markets and communicate to the public.
So if Mr Warsh wanted to deviate substantially from where the committee was, he would have to build a consensus to do that.
So we think at least in the near term, the reaction function won't change.
It'll be driven by the data whether the labor market holds up, whether inflation decelerates as expected.
So we don't look for material change.
Now, you also asked about the medium term.
I do think where his views differ, at least with respect to current Fed policy, is on the size of the Fed's balance sheet and its footprint in financial markets.
So he has argued over time for a much smaller balance sheet.
He's called the Fed's balance sheet bloated.
He has said that it creates distortions in markets, which mean interest rates could be higher than they otherwise would be.
And so I think if there is a substantive change in Fed policy going forward, it could be there on the balance sheet.
But what I would just say on that is it'll likely take a lot of coordination with Treasury.
It will likely take changes in rules regulations, the supervisory landscape, because if you want to reduce the balance sheet further without creating volatility in financial markets, you have to find a way to reduce bank demand for reserves.
So this will take time.
It'll take study.
It'll take patience.
I wouldn't look for big material changes right out of the box.
So, Matt, what I'd like to do is if I could flip it back to you.
Warsh was certainly one of the expected candidates, right?
So his name is not a surprise.
But as we knew, financial markets one day were thinking it'd be one candidate.
The next day, it'd be thinking it was somebody else.
How did you see markets reacting to the announcement of Mr. Warsh for the next Fed share?
And then maybe put that in context of where markets were coming out of the last FOMC meeting.
Yeah, so the markets that moved the most were not the traditional very large macro markets like the interest rate marketplace or the foreign exchange market.
The markets that moved the most were the prediction markets, these newer markets that offer investors the ability to wager on different outcomes for a whole variety of events around the world.
But when it comes to the implications of a Kevin Warsh-led Fed for the bigger macro markets, like interest rates and currencies, the question really comes down to how, if the Fed's balance sheet policies are going to take a while to implement, those are not going to have an immediate effect, at least not an effect that is easily seen with the human eye.
But it's other types of policy change in terms of his communication policy, for example.
One of the points that you raised in your recent note Mike, was how Kevin Warsh favored less communication than perhaps some of the recent federal open market committees had with the public.
And so if there is some kind of a retrenchment from the type of – over communication to the marketplace from either committee members or non-voters, that could create a bit more volatility in the marketplace.
Of course, the Fed has been one of the central bank's that does not like to surprise the markets in terms of its monetary policy making.
And so that contrasts with other central banks in the G10.
For example, the Swiss National Bank tends to surprise quite a lot.
The Reserve Bank of Australia tends to surprise markets more often certainly than the Fed does.
So, to the extent that there's some change in communication strategy going forward, that could lead to a more volatile interest rate in currency markets.
And that then could cause investors to demand more risk premium to invest in those markets.
If you previously were comfortable owning a longer duration treasury security fund because you felt very comfortable with the future path of Fed policy, then a Kevin Warsh-led Fed, if it decides to change the communication strategy, could naturally lead investors to demand more risk premium in their investments.
And that, of course, would lead to a steeper U.S.
Treasury curve, all else equal.
So that would be one of the main effects that I could see happen in markets as a result of some potential changes that the Fed may consider going forward.
So Mike, with that said, this was the first FOMC meeting of the year and the next meeting arrives in March.
I guess we'll just have to wait between now and then to see if the Fed is on hold for a longer period of time or whether or not the data convinced them to move as soon as the March meeting.
Thanks for taking time to talk, Mike.
Great speaking with you, Matt.
And thanks for listening.
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