A hawk at the door?
Markets stayed calm in January as liquidity remained easy, even with a new Fed chair nominee seen as a balance sheet hawk and policy questions beginning to build.
The most consequential development of the month came with President Trump’s nomination of Kevin Warsh as the next US Federal Reserve (Fed) Chair, ending months (felt like years) of speculation and refocusing attention on the Fed’s balance sheet and policy framework.
His nomination would see him assume Stephen Miran’s seat on the Federal Open Market Committee (FOMC), effectively replacing an unabashed dove with a figure who—despite his stance favoring lower policy rates—showed a distinctly hawkish streak during his previous tenure when inflation risks rose.
While Warsh must still clear the Senate, we see confirmation as largely a formality. A front runner for the role of Chair back in 2018, Warsh in fact does not have an advanced degree in economics but is a lawyer by academic training. How fitting. He was appointed by President G. W. Bush to serve as a Fed Governor at age 35 (2006-2011). Warsh had long argued that the balance sheet has grown excessively, warning that continued expansion risks blurring the line between monetary and fiscal policy and eroding the Fed’s credibility.
Within the FOMC, broad support for an ample reserves regime suggests that any balance sheet normalization would be gradual and likely require compromise on its terminal size rather than a wholesale shift in the monetary framework.
Markets are already debating the implications of a Fed leadership that may place less emphasis on longer term inflation risks, with expectations tilting toward a steeper yield curve (I see the first round of name-calling at the December FOMC meeting).
From a markets perspective, January, as usual, “came in hot.” Flows were positive and the maturity schedule is heavy, pushing technicals tighter. Spreads have rallied across fixed and float, with fixed looking a bit too proud of itself at 3–4 bps tighter. There’s not much value in extending out the curve unless you enjoy chasing things that don’t want to be caught. Most investors are holding back, waiting for February to offer better levels, while fund durations naturally roll down as everyone resists the urge to buy at today’s highs.
Despite geopolitical theatrics—Greenland resolutions, Canadian tariffs, and the usual pre midterm political fireworks—there’s still plenty of cash sloshing around. It’s a seller’s market, plain and simple. And with the administration trying to keep the music playing through the midterms, volatility may show up, but liquidity is not exactly in short supply.
On the funding side, Q1 looks calm. The money market system capacity is expanding as global systemically important bank balance sheets rebound from their Q4 contortions, and banks may opt into lighter supplementary leverage ratio requirements. The Fed is gobbling up T bills at a quick clip through Reserve Management Purchases —about $40B a month into April, before slowing to something closer to $25B. Add another $15B from mortgage-backed securities reinvestments, and you’ve got a central bank that’s basically the MVP of the T bill market.
Treasury’s April tax haul may lift the Treasury General Account to roughly $1.1 trillion, though the timing of payments and refunds is anyone’s guess. Even with the Fed offsetting some of the drain, reserves could drift down toward $2.8 trillion.
Net T bill supply for the year sits around $700B, with the Fed expected to buy about $500B of that, leaving the private market an easy $200B to absorb—unless fiscal “surprises” show up. Tariff refunds could add $200B. Stimulus checks—because elections—could add another $300–600B. Pick your adventure.
Another data point to watch is the BLS’s QCEW (Quarterly Census of Employment and Wages) labor force revisions. Revisions have been coming in lower than expected and showing a labor market that is weaker than the headline non-farm payroll data is showing. If we see another major downward revision, it could mean the Fed starts to think harder about a cut in interest rates. As of right now our forecast is a 25 bps cut at the April meeting, followed by two more cuts in Q3 and Q4. Given the news flow and headline risk, your guess is as good as mine.