Kevin Warsh Might Want to Study This Mike Tyson Quote
As Warsh steps into the ring as Fed chair, he’ll have to dodge punches from economy, war on Iran and possibly the president.
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Kevin Warsh begins his tenure as chairman of the Federal Reserve in an unenviable position. The U.S. economy has slowed from just over 4% gross domestic product growth across second and third quarters to 1.25% growth over Q4 and Q1. The economy has become highly dependent on the surge in tech spending around the massive AI buildout happening across the nation. This activity contributed roughly 70% of GDP growth in Q1.
Warsh also faces a balance sheet problem with federal debt nearing $40 trillion and with the U.S. running close to a $2 trillion annual fiscal deficit. Neither party has any desire to reduce spending or even begin to tackle this issue. In fact, the administration is asking for the biggest percentage increase in defense spending since WWII within the fiscal 2027 federal budget. The debt-to-GDP ratio is close to WWII territory as well.
After making yeoman’s progress reducing inflation rates since the consumer price index peaked at 9.1% in June 2022, the latest U.S. adventure in the Middle East has spiked energy and commodity prices since the end of February. There remains no credible plan yet to reopen the critical Strait of Hormuz that continues to be a choke point for the global economy. It is little comfort that the U.S. is faring better than either Europe or Asia, thanks to our oil and natural gas production. Substantial food inflation is now firmly in the pipeline and tens of millions in poorer and developing countries in regions like Africa face coming food insecurity, given how much of the global components for fertilizer remains locked in.
Pain from the effective closure of the Strait of Hormuz is already showing up here in the United States, too. Both April’s consumer price index and, more concerningly, the producer price index reading last week, came in far hotter than expected. Gas prices surging past the four-buck-a-gallon threshold for the first time since 2022 have helped push consumer sentiment down to the lowest levels since the University of Michigan began polling this metric back in 1978.
The yield on the 30-Year treasury just surged decisively above the 5% level for the first time since 2007, just before the Great Financial Crisis. At the same time, 10-Year gilts in the U.K. have also moved over 5% for the first time since 2008 as sovereign debt worries have increased notably.
Warsh’s first move may end up being a rate hike, something that will put him in hot water with the POTUS who appointed him and who is not shy about jawboning. That also would not be good news for equities that are sporting extreme valuation levels viewed by a historical lens. The Shiller price-to-earnings ratio is around 42. It has never been higher outside a brief period at the tail end of the Internet Boom, more than a quarter century ago.
The markets have not welcomed new Fed Chairmen kindly in recent history. Alan Greenspan had to face Black Monday in 1987, less than three months after he took the helm of the central bank. Ben Bernanke, within a year of being appointed, had to navigate the subprime crisis which he infamously called “contained” in May 2007.
Mr. Warsh’s desire is to deleverage the Fed’s balance sheet. That is an admirable goal given that the balance sheet is more than eight-times larger than where it stood before the Great Financial Crisis, even as it has been trimmed somewhat in recent years. And I fear given the myriad challenges the new Fed chairman faces as he begins his tenure, Warsh might soon discover the wisdom of Mike Tyson’s famous quote, “Everyone has a plan until they get punched in the face.”
At the time of publication, Jensen had no position in any security mentioned.
