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The Macro Brief – What will a Warsh Fed look like?
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In this US special, Ryan Wang, Dhiraj Narula and Saul Martinez look at what’s next for the Federal Reserve, the impact of recent supply shocks, and how consumers are showing resilience despite rising costs.
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Transcript
Inflation and Rate Cut Prospects
00:00:00
Speaker
On our own forecast, inflation does not fall that much. And that's really the key reason we don't expect rate cuts. But if inflation does fall at least below 3% and then below 2.5%, then I think the Fed probably would return to consideration of rate cuts.
Introduction to Macro Brief Podcast
00:00:24
Speaker
Hello, I'm Aline Van Dyne in New York and welcome to the Macro Brief from HSBC Global Investment Research, the podcast that looks at the issues driving financial markets around the world.
Leadership Change at the Fed
00:00:37
Speaker
Today, we're asking what a Federal Reserve under Kevin Walsh will look like. Mr. Walsh is due to take over at the US Central Bank next month.
00:00:48
Speaker
So will the Fed be more or less likely to cut rates? Is the U.S. economy running hot or cold? And what will Kevin Walsh's communication style be like?
00:01:00
Speaker
To find out, I'm joined by two regulars to this podcast, Ryan Wang, our U.S.
FOMC Meetings 2026 Overview
00:01:06
Speaker
economist, and Deiraj Narula from the Rate Strategy team, as well as Saul Martinez, our head of U.S. financials research, who will give us some insights on the state of the U.S. consumer.
00:01:19
Speaker
Welcome to all of you. Thanks for having us. Thank you. Thank you, Elaine. So let's kick off with where we are at the moment. What did the FOMC decide this week, Ryan? What's the state of affairs?
00:01:33
Speaker
Well, the FOMC hasn't really taken much action this year. So this was the third meeting of 2026, and it was the third meeting. The policy rate was kept unchanged. Now, there was a lot of debate that we learned about the Fed's communications about what may happen going forward, and that was the debate about will we ever see a return to rate cuts, which the Fed did deliver in 2024 and 2025. But so far, no action.
Dissent on Fed's Communication Strategy
00:01:56
Speaker
So those dissenters, what exactly did they disagree with? What's that dissent? Yeah, so in terms of the official voting, and there's always 12 voters on the FOMC at any given point in time, and nine of those voters were still supportive of what we call an easing bias in the statement, which basically just says, okay, we may be staying unchanged right now, but the next move is more likely to be a rate cut rather than a rate hike.
00:02:24
Speaker
But at least three policymakers said, no, the risks to inflation are at least as significant as, let's say, the downside risks to growth or to the labor market. And therefore, the communication should also be neutral.
Market Sentiments and Fed's Stance
00:02:36
Speaker
It's quite unusual for people to dissent on the communication, right? Yeah, it doesn't come up that often, although over recent decades, forward guidance has been used to influence the markets and, in particular, interest rates. So even if the short-term policy rate is not being changed, this sort of discussion does have importance. And it will continue to have importance under the new Fed chair, Kevin Warsh.
Inflation Influences and Fed Forecasts
00:02:58
Speaker
In terms of forward guidance, Deiraj, was there any reaction in the market? How has market sentiment and expectations on U.S. rates changed?
00:03:09
Speaker
So I think the bond market is very much in line with sort of this shift in Fed communication, or at least indications that there is a desire by some policymakers to remove that easing bias.
00:03:22
Speaker
For much of this year, and indeed the Fed's easing cycle so far, we've seen the bond market sort of continue to look for rate cuts beyond what's being delivered. And that comes despite the fact that the labor market or the job side of the Fed's mandate has remained relatively resilient. while the inflation side has continued to remain above the Fed's own target. ah What we've seen in the past 24 hours, though, really since the FOMC meeting, is that the bond market has now removed that easing bias from its own pricing. The forward rates for 2026 now imply a Fed on hold throughout the rest of this year and really, indeed, through the rest of 2027,
Challenges of Inflation on Consumer Power
00:03:58
Speaker
which suggests a kind of shift in baseline from looking for more easing to really neither looking for more easing or hikes from here.
00:04:06
Speaker
Ryan, that's been your forecast for some time, a Fed on hold. Let's just pull back and talk about the economic reasons why we're talking about the removal of easing bias, etc. This is related to inflation. Presumably, there is a link to recent higher energy prices, what's been going on with tariffs, the conflict in the Middle East.
00:04:29
Speaker
Where do we stand on that front? Yeah, absolutely. And this came up Jerome Powell's press conference. He talked about a series of supply shocks and the two most recent ones, I think, clearly we have the conflict in the Middle East and the recent surge in energy prices. I wouldn't say that's so much what's what is currently boosting core inflation. It has already boosted overall inflation. But the tariffs, ah the Fed certainly believes, is having a significant impact on the current inflation numbers. A recent Fed staff estimate said as much as
00:05:01
Speaker
0.8 percentage points, almost a full percentage point of that over 3% inflation is probably due to tariffs. And the other side of that implication is that if we wait towards the end of the year, the current inflation rate may be much lower.
00:05:14
Speaker
On our own forecast, inflation does not fall that much. And that's really the key reason we don't expect rate cuts. But if inflation does fall at least below 3% and then below 2.5%, then I think the Fed probably would return to consideration of rate cuts. And if inflation rises further, again, you know, you say that energy shock hasn't really been reflected yet.
00:05:38
Speaker
If that does become an issue, if inflation does rise further, is there the potential for rate hikes? This is a challenge. it it was a challenge under the Powell-led Fed in terms of how to react. And it will be a challenge under the Walsh-led Fed because the issue is that, yes, inflation will go higher.
00:05:54
Speaker
But the consumer also has less purchasing power because of more expenditure on energy, especially gasoline,
Consumer Spending Amid Inflation
00:06:01
Speaker
right? So it's a downside risk to growth simultaneously as an upside risk to inflation. So it's very hard to determine how and particularly when the Fed will act.
00:06:09
Speaker
So you mentioned the consumer. Saul, you cover U.S. financials. There's been quite a few results from the big financial institutions in the U.S. What are those results telling us about the state of the U.S. consumer?
00:06:24
Speaker
Because it's surprisingly resilient. Yes, and it has been resilient for some time. So we have had the largest banks, the largest consumer finance companies, and now Visa report earnings. And what what the results are showing is a healthy economy and a healthy consumer.
00:06:39
Speaker
The consumer is annoyed, but you know what? They are still spending. And we look at perhaps the most obvious thing to look at in the results are just the purchase volume dynamics. What is a purchase volume on credit cards and debit cards doing for the largest banks and obviously for the networks? And you have seen anywhere from mid-single digit to low double-digit year-on-year growth with a modest acceleration in trends versus recent quarters. Now, what you are seeing is the higher income still doing better. So if you look at American Express, whose customer base is more affluent, it is growing faster than those of others. High single digits, 10%.
00:07:17
Speaker
But you hear a lot about the K-shaped economy. I think the economy is more E-shaped than K-shaped. And what do I mean by that? The higher income segments are growing more. Their volumes are growing more. They're doing better.
00:07:30
Speaker
But the lower income segments, even though the the purchase volume trends are less dynamic, they're not worsening. The trend line is the same. And in fact, it actually improved a little bit this quarter for companies like Synchrony, who have a bit more subprime in their in their mix. So even at the low end, you're seeing good volume growth. Now, we also look at measures of financial health. What are credit quality metrics doing? What are delinquency ratio metrics doing? Across the board, they're improving year on year, and they have been improving for some time. And things like payment rates as well, like what proportion of loan balance are being paid off. They are still at historically high levels. um That's not good for balance sheet growth, but it is good. It is a ah positive indication here. And I think ultimately, though, the labor market is the linchpin for all of it. I said consumers are annoyed, but they're still spending.
00:08:14
Speaker
As long as you have real wage growth, as long as people are employed, Americans are going to spend. And I think you're seeing that in
Bond Market and Consumer Health
00:08:21
Speaker
the numbers. So does this surprise ah you at all, Saul? I mean, is this common at this stage in the cycle?
00:08:29
Speaker
i am not surprised. This is an unusual cycle. It's hard to say at this point in the cycle because we have not had a cycle since 2008. So yeah at some point, we will get a credit cycle, either in the commercial sphere or in the consumer sphere or both.
00:08:46
Speaker
But gasoline, the the initial impact is likely going to be limited. Who is driving the the bulk of the growth is a higher income segment. It's a low single-digit proportion of their budget. The real impact of this stuff really happens when you start to see the the filtering through of higher ah input costs, a higher transportation cost. And if that affects companies' profit margins and leads them to rationalize their cost structure in a way where you start to see increases in in unemployment, then that becomes a risk. But for now, things are good. And as long as nominal real world wage growth is positive, it's not surprising that the the spending patterns are what they are.
00:09:28
Speaker
Dheeraj, is this reflected also in the bond markets more generally, looking beyond treasuries in credit markets, etc.? Like, how is this echoed?
00:09:38
Speaker
Yeah, so I think broadly, the bond market, both within the treasury market and spread products, what we call credit products that compensate investors for additional credit risk, they remain relatively healthy with respect to the state of the consumer financial And really not priced in fears of meaningful financial stress. I mean, we've had, of course, private credit be a big theme. But in terms of whether whether that's being priced as any kind of systemic risk, that's really not something we've seen. I think overall, the bond market believes in this kind of healthy consumer, healthy overall system story that Sal has been talking about.
00:10:15
Speaker
Shifting back to the Fed and what Kevin Walsh has to deal with when he becomes the Fed chair soon, how
Potential Shifts in Fed Communication
00:10:23
Speaker
does this solid consumer relative strength in the real economy, how do these dynamics play out?
00:10:31
Speaker
So, I think there definitely is going to be a challenge, and a lot of it relates to what t Saul and Dheeraj were just talking about. you know There's very much a circularity between how the economy is performing and also how the markets are doing, right? And Saul mentioned, okay, part of that stems from what economists tend to call wealth effects, which you know basically means if the stock market is booming, that tends to feed into stronger spending. But it also really comes down to the labor market. And um you could easily imagine that unless businesses really begin to engage in widespread layoffs, then perhaps the credit spread metrics that D. Raj was talking about will remain relatively
00:11:05
Speaker
ah healthy, you know not really showing signs of of stress. And in that environment, it's going to be difficult for the Fed to say, you know rate cuts are needed right now to support the economy. right And therefore, I would go back to what I said earlier, which is that we may not see rate cuts unless inflation makes significant downward progress down towards 2%. So it's, you know, another way to frame it is, are we talking about good news rate cuts or bad news rate cuts? Bad news meaning the labor market is really showing showing signs of cracking. and And really that comes down to an acceleration in layoffs.
00:11:36
Speaker
Question for Ryan, in terms of this complicated outlook that Ryan's been talking about, there's so many different vectors impacting both the Fed's thinking as well as overall global markets. And one of the things that incoming Fed Chair Kevin Warsh has talked about is the Fed's communication pattern and how forward guidance works, its economic projections, its indications of the policy path ahead. I'm curious, Ryan, what your thoughts are in terms of whether we get a change in the communication styling time soon, what that means for how the Fed approaches, i guess, meeting by meeting policy.
00:12:10
Speaker
Yeah. i Listen, I think the clearest message so far that we heard from Kevin Warsh is to, in in some way, not engage in in in fine-tuning of policy. you know there's There's a related issue of how you conduct policy and then what measures you focus on. And so you know at Kevin Warsh's recent nomination hearing, he talked about okay, maybe we shouldn't put all of our eggs in a single inflation basket. Like I talked about this core PCE measure, which the Fed has historically focused on, ah but every measure has its imperfections. And so ah Kevin Warsh talked about maybe we should look at so-called trim mean measures. So taking a broader view and not trying to, you know, over manipulate the economy and in ways that are probably very difficult is is something that I think Kevin Warsh has expressed a preference for. Now, how it plays out in practice, I think will take some time. You know, I think Kevin Warsh will need to build a consensus on the entire FOMC, but there's no question that leadership and communication style will make a big difference.
Fed's Independence and Consensus Building
00:13:09
Speaker
um Now, I could turn that back to you, Deraj. I mean, how do you think this transition from Powell to Warsh and communications could impact the bond market?
00:13:17
Speaker
Sure. So I think The communication angle is a very interesting one for the bond market because we've been in a regime for the past couple of years where for the majority of FOMC meetings, the bond market has actually long priced in that particular decision. And the market then focuses more on the content of the press conference, the composition of the Fed's forward guidance, etc. If we do move to an environment where there is a broader range of variables being considered, there's less of a commitment or less of indication of a commitment to a policy path, then that could elevate uncertainty around individual decisions and that could lead to higher volatility in the bond markets. Whether that's significant enough to meaningfully shift the amount of premium that investors require, that, of course, remains to be seen. There's a lot of different aspects that come into this. And I think the sequencing of policy, if we do get changes coming in from a Kevin Warsh-led Fed, is certainly something to watch out for.
00:14:11
Speaker
Ryan, what about the discussion around Fed independence? President Donald Trump has suggested he'd like the Fed to cut rates. Where are we in that story? Will that continue to also add uncertainty to the picture?
00:14:29
Speaker
Well, it's an interesting question. So the other thing we learned from Jerome Powell at his final press conference as chair is that it will probably not be his final meeting as a member of the Board of Governors. ah So Powell has told us that he will stay on the Board of Governors at least to see through the final conclusion of these outstanding Department of Justice criminal investigations that are related to Fed building renovations. And so, you know, in the fullness of time, if and when those investigations are concluded, we may say see Jerome
Future Discussions Under New Fed Leadership
00:15:01
Speaker
Powell leave the Fed. But at a very bare minimum, he will see through this particular independence-related issue.
00:15:08
Speaker
ah I would, in a way, separate that from the broader discussion which I alluded to, which is that Kevin Warsh will be the Fed chair. but will need to manage an entire FOMC to drive the policy that he's looking for. The chair needs to build consensus. You do basically have, I mentioned 12 voting FOMC members, but there's 19 overall. That's a big group of people to try to get on the same page.
00:15:31
Speaker
Well, thank you all very much. And I think we're going to have quite a lot to talk about in the next year. So let's get back when ah Kevin Walsh is in the seat and and see what's happening. Thank you.
00:15:44
Speaker
Thanks having us. Thank you.
00:15:52
Speaker
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00:16:03
Speaker
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00:16:15
Speaker
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00:16:34
Speaker
So that's it from us. This week's macro brief was hosted by me, Aline Van Dyne, here in our New York studio and produced by Tom Barton in London.
00:16:45
Speaker
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