WEBVTT - Understanding Kevin Warsh's Plan for the Fed 0:00:00.280 --> 0:00:09.440 Bloomberg Audio Studios, podcasts, radio news. I'll tell you if 0:00:09.560 --> 0:00:11.400 our new head of the Fed, who I think is 0:00:11.440 --> 0:00:13.720 going to be great, if he does the job that 0:00:13.760 --> 0:00:17.759 he's capable, we can grow at fifteen percent. I think 0:00:17.800 --> 0:00:18.360 more than that. 0:00:27.920 --> 0:00:30.760 I'm Stephanie Flanders, head of Government and Economics at Bloomberg 0:00:31.000 --> 0:00:33.680 And this is Trumpanomics, the podcast that looks at the 0:00:33.680 --> 0:00:36.880 economic world of Donald Trump, how he's already shaped the 0:00:36.880 --> 0:00:40.040 global economy, and what on earth is going to happen next. 0:00:41.600 --> 0:00:43.839 This week, we look at what some would say was 0:00:43.880 --> 0:00:47.760 the single most important personnel decision that Donald Trump has 0:00:47.880 --> 0:00:50.920 made in the last year, choosing Kevin Walsh to be 0:00:50.960 --> 0:00:54.800 the next Chairman of the Federal Reserve. Assuming Wassh is confirmed, 0:00:55.120 --> 0:00:57.560 that's one piece of Trump Andnomics we can expect to 0:00:57.600 --> 0:01:01.320 be shaping the American and globe bull economy for some 0:01:01.480 --> 0:01:04.840 time after the President himself has gone. So how will 0:01:04.880 --> 0:01:08.720 mister Walsh lead the world's most important central bank? And 0:01:08.760 --> 0:01:11.280 with relations between the Fed and the White House quite 0:01:11.319 --> 0:01:14.480 so fraught, will he be able to win the internal 0:01:14.560 --> 0:01:18.640 support he needs to be effective given the intensely political 0:01:18.680 --> 0:01:21.560 build up to his appointment. For what it's worth, the 0:01:21.600 --> 0:01:23.960 market moves in the days when the choice of Kevin 0:01:24.000 --> 0:01:27.840 Walsh was confirmed in mid January suggests investors think he 0:01:27.920 --> 0:01:30.679 won't let policy be dictated by the president and won't 0:01:30.760 --> 0:01:33.319 let inflation run a mup. You can see that in 0:01:33.360 --> 0:01:36.240 the rise and the dollar, and most strikingly in the 0:01:36.319 --> 0:01:40.240 dramatic fall in the price of gold and silver. And 0:01:40.319 --> 0:01:43.400 yet there are big areas of uncertainty about what Walsh 0:01:43.680 --> 0:01:47.240 really thinks about monetary policy and interest rates, and about 0:01:47.240 --> 0:01:50.200 his plans for the FED itself, which he's been pretty 0:01:50.200 --> 0:01:53.040 critical of in the past. When I was thinking about 0:01:53.080 --> 0:01:56.360 the people who could both understand this story and explain 0:01:56.480 --> 0:01:59.440 how markets were thinking about it, my friend Krishna Guha 0:01:59.600 --> 0:02:01.680 was the first name that came to mind. Krishner is 0:02:01.720 --> 0:02:04.120 the vice chairman and head of Economics and Central Bank 0:02:04.160 --> 0:02:08.400 Strategy at the investment research group Evercore ISI. Before Evercore, 0:02:08.560 --> 0:02:10.880 he was an executive vice president at the New York Fed, 0:02:11.120 --> 0:02:13.880 and we also overlap briefly at the Financial Times many 0:02:13.960 --> 0:02:16.560 years ago, where Krishna was a senior writer on global 0:02:16.600 --> 0:02:23.040 economics and economic policy. Firstly, I guess we had that 0:02:23.120 --> 0:02:28.960 quite dramatic market reaction to his appointment, seeming the investors 0:02:29.040 --> 0:02:32.360 drawing some quite clear conclusions about what he was going 0:02:32.400 --> 0:02:34.320 to mean for the FED and not mean for the FED. 0:02:34.400 --> 0:02:37.680 How did you interpret the reaction and what were some 0:02:37.720 --> 0:02:38.920 of the key takeaways for you. 0:02:39.240 --> 0:02:41.760 So we thought going in that the market would initially 0:02:41.840 --> 0:02:47.760 trade Wash hawkish, so rates higher, yield curved steeper because 0:02:47.800 --> 0:02:50.440 of his balance sheet views and concerns that he might 0:02:50.520 --> 0:02:54.680 restart QT to shrink the Fed's balance sheet, risk off 0:02:54.840 --> 0:02:58.480 in stocks and dollar higher, as he would be seen 0:02:58.480 --> 0:03:01.760 as more of a strong dollar candidate. So the market 0:03:01.800 --> 0:03:06.000 reactions that we've seen, which have broadly gone in those directions, 0:03:06.240 --> 0:03:09.880 I don't think are surprising. At the same time, though, 0:03:10.240 --> 0:03:14.320 my own view is that the market reaction also reflects 0:03:14.720 --> 0:03:18.440 a sense that people don't really understand exactly what kind 0:03:18.440 --> 0:03:21.120 of central bank governor Wash is going to be. I 0:03:21.160 --> 0:03:25.519 think that's reasonable. My own views are that Kevin Walsh 0:03:25.600 --> 0:03:29.560 is unlikely to be an ideological hawk and is more 0:03:29.760 --> 0:03:32.359 likely to be in many respects quite pragmatic. 0:03:33.639 --> 0:03:36.240 Yes, So let's talk about the monetary policy kind of 0:03:36.280 --> 0:03:38.280 interest rate piece first, and then we'll get into that 0:03:38.320 --> 0:03:40.600 the balance sheet things, which for some people will be 0:03:41.360 --> 0:03:44.040 less familiar territory. The reason I guess that there is 0:03:44.080 --> 0:03:47.240 a bit of uncertainty about him is on this point, 0:03:47.560 --> 0:03:49.880 is that he had previously been a hawk, and in fact, 0:03:50.000 --> 0:03:52.560 as our own chief US economist pointed out, if you 0:03:52.600 --> 0:03:55.320 look at his record, he was at the FARED two 0:03:55.360 --> 0:03:58.720 thousand and six twenty eleven, he was more concerned about 0:03:58.760 --> 0:04:02.320 inflation for longer than most governors. So if you look 0:04:02.360 --> 0:04:04.560 at the sort of minutes, it was more worried about 0:04:04.600 --> 0:04:08.160 inflation than downside risk as late as April two thousand 0:04:08.160 --> 0:04:10.160 and nine, so right through two thousand and eight and 0:04:10.240 --> 0:04:13.480 April two thousand and nine, and only really eased up 0:04:13.520 --> 0:04:16.680 on worrying about inflation August two thousand and nine. So 0:04:17.160 --> 0:04:20.599 it's quite striking to hear him now since he's been 0:04:21.080 --> 0:04:23.560 in the running to be Trumb's pick for FED chair, 0:04:24.000 --> 0:04:27.839 emphasizing a rather different approach, seemingly rather different approach, but 0:04:27.920 --> 0:04:31.000 he's pinning it on the impact of AI on productivity 0:04:31.040 --> 0:04:33.200 on the economy, and that's what he can say has 0:04:33.360 --> 0:04:35.520 changed since two thousand and nine, And do you take 0:04:35.520 --> 0:04:36.400 that at face value? 0:04:36.680 --> 0:04:39.840 So I think it is true that Kevin Walsh has 0:04:40.400 --> 0:04:45.160 for most of his career has channeled and represented what 0:04:45.160 --> 0:04:49.560 one might think of a small C conservative Republican leaning 0:04:49.800 --> 0:04:54.480 economic thinking and principles, there has generally been more concerned 0:04:54.640 --> 0:04:59.040 with inflation than the labor market, let's say, more focused 0:04:59.040 --> 0:05:03.800 on supply issues than demand side management. And so I 0:05:03.800 --> 0:05:06.640 think there is an aspect that is channeling a set 0:05:06.680 --> 0:05:09.000 of thinking on one side, if you like, of the 0:05:09.040 --> 0:05:12.880 political and economic debates. But I think what Kevin would 0:05:12.880 --> 0:05:16.800 say if he was on this call is that there 0:05:16.920 --> 0:05:19.559 is a consistency in the way that he thinks about 0:05:19.600 --> 0:05:23.159 inflation risks. So, first of all, Kevin is someone who, 0:05:23.440 --> 0:05:27.480 as I mentioned, thinks that a lot of fed type thinking, 0:05:27.640 --> 0:05:29.719 a lot of New kaynes In type thinking, and the 0:05:29.800 --> 0:05:33.080 modeling that's come from that puts a lot too much 0:05:33.160 --> 0:05:36.320 weight on the demand side of the economy and unemployment 0:05:36.560 --> 0:05:41.400 as a predictor and driver of inflation. Kevin's view is 0:05:41.440 --> 0:05:44.960 that when the economy strengthens, or indeed weakens, the first 0:05:45.040 --> 0:05:47.479 question you should be asking is whether it's supply driven 0:05:47.560 --> 0:05:50.160 or demand driven. And then, of course the implications of 0:05:50.200 --> 0:05:54.200 the economy are potentially very different, as are the implications 0:05:54.240 --> 0:05:57.039 for rates in those two cases. I think it's also 0:05:57.120 --> 0:05:59.880 the case that Kevin believes that the really big inflation 0:06:00.160 --> 0:06:04.440 risks come when you have a combination of fiscal expansion 0:06:04.440 --> 0:06:07.320 on the part of the government and money financing on 0:06:07.400 --> 0:06:09.240 the parts of the central bank. Now, of course the 0:06:09.240 --> 0:06:11.359 FED would argue that it hasn't been doing that, But 0:06:11.480 --> 0:06:15.200 Kevin would say, the government issues bonds to finance fiscal 0:06:15.240 --> 0:06:18.120 stimulus on Monday, and the FED buys bonds in the 0:06:18.160 --> 0:06:22.440 market on Thursday, it's coming fairly close to money financing 0:06:22.760 --> 0:06:26.560 that fiscal expansion. So with respect to the GFC in 0:06:26.600 --> 0:06:28.680 all Canada, my own view at the time as now 0:06:28.760 --> 0:06:31.719 was that Kevin is simply wrong in his assessment. But 0:06:32.000 --> 0:06:33.520 if we think of, say, the difference between where we 0:06:33.560 --> 0:06:36.839 are now and the early phase of the pandemic inflation, 0:06:37.520 --> 0:06:39.400 Kevin would have said, what do we have then? We 0:06:39.440 --> 0:06:42.400 had an impaired supply side, We had a lot of 0:06:42.400 --> 0:06:45.120 fiscal stimulus, and we had a central bank that was 0:06:45.200 --> 0:06:48.599 money financing and expanding its balance sheet. That, in Kevin's world, 0:06:48.640 --> 0:06:52.560 is a recipe for high inflation. What do we have today? 0:06:53.080 --> 0:06:56.520 We have a positive supply shock. We have a large 0:06:56.520 --> 0:06:58.920 government deficit that Kevin certainly thinks in the long run 0:06:59.000 --> 0:07:02.000 is not likely to be sustainable at these levels. But 0:07:02.000 --> 0:07:04.000 it's not going up or down because the tariff take 0:07:04.080 --> 0:07:05.960 is roughly the same as the one Big Beautiful Bill 0:07:06.279 --> 0:07:10.120 fiscal giveaways, and there's no central bank money financing or 0:07:10.160 --> 0:07:13.440 balance sheet expansion. So Kevin would say the inflation risks 0:07:13.480 --> 0:07:17.120 today are completely different from the inflation risks that were 0:07:17.120 --> 0:07:19.240 there in the early phase of the pandemic, which is 0:07:19.240 --> 0:07:22.120 why I was a hawk then and I'm a dove now. 0:07:23.160 --> 0:07:25.200 And obviously there's a lot of uncertainty about what the 0:07:25.240 --> 0:07:27.280 impact of AI is going to be on the economy, 0:07:27.440 --> 0:07:30.920 And there are many people who can look at where 0:07:30.960 --> 0:07:33.920 inflation is now in the US and the sort of 0:07:33.960 --> 0:07:36.320 possibility that you will actually have a fair amount of 0:07:36.320 --> 0:07:38.480 stimulus coming down the track as a result of the 0:07:38.480 --> 0:07:41.680 Big Beautiful Bill and other things. So I get the 0:07:41.760 --> 0:07:44.360 jury is out on what happens to inflation over the 0:07:44.360 --> 0:07:48.040 next year or two, whether it makes sense to continue 0:07:48.080 --> 0:07:52.440 cutting rate or Eve cut them faster after Kevin wash, 0:07:52.440 --> 0:07:56.000 assuming he becomes fed chair but you know him pretty well. 0:07:56.200 --> 0:07:58.080 How much is he going to be data driven? Now? 0:07:58.120 --> 0:07:59.600 Much is he going to be willing to sort of 0:07:59.680 --> 0:08:02.880 change his mind in the face of the evidence or not. 0:08:03.120 --> 0:08:06.920 Yeah, Kevin's ideal central Bank governor is someone who would 0:08:06.960 --> 0:08:10.640 be fifty percent Alan Greenspan fifty percent stand Drucamiller. Why 0:08:10.680 --> 0:08:13.840 green Span because green Span was, of course the man 0:08:13.840 --> 0:08:16.120 who knew he was the one who would look in 0:08:16.240 --> 0:08:20.280 the fine detail of the obscure economic statistics and private 0:08:20.280 --> 0:08:23.800 sector data and discern what was really happening in the 0:08:23.880 --> 0:08:26.400 economy that would show up in the official data many 0:08:26.440 --> 0:08:29.679 months in the future. And then, of course Drucamiller being 0:08:29.840 --> 0:08:33.080 by many counts one of the greatest macro hedge fund 0:08:33.160 --> 0:08:35.720 managers and somebody who had the ability to see in 0:08:35.880 --> 0:08:39.600 market the signals about not just where the economy is today, 0:08:39.640 --> 0:08:42.560 but where the economy would be going in the future. 0:08:43.040 --> 0:08:47.160 So what Kevin will aspire to do is to have 0:08:47.280 --> 0:08:51.480 a more forward looking and richer, more nuanced sense of 0:08:51.559 --> 0:08:53.760 the outlook for the economy and the bounds of risks 0:08:54.280 --> 0:08:57.679 then you would get by simply plugging last month's employment 0:08:57.720 --> 0:09:02.320 report or CPI data into a model like FRBUS at 0:09:02.320 --> 0:09:05.559 the FED. So he's quite scornful of some of those 0:09:06.240 --> 0:09:08.520 models and the sort of culture of what he would 0:09:08.559 --> 0:09:11.320 say is backward looking data dependency. So I think he 0:09:11.440 --> 0:09:16.000 will try to be yet informed by data, but putting 0:09:16.080 --> 0:09:18.319 more weight on some of the sort of micro corporate 0:09:18.400 --> 0:09:21.760 level data on the one hand, and market signals as 0:09:21.880 --> 0:09:25.240 data on the other, relative to, if you like, the 0:09:25.679 --> 0:09:29.680 top tier economic releases. What I would say with respect 0:09:29.720 --> 0:09:32.800 to that approach is that I have I have a 0:09:32.800 --> 0:09:35.480 lot of sympathy with the idea that we should, we 0:09:35.559 --> 0:09:38.640 really should aim to do better than simply used last 0:09:38.640 --> 0:09:41.720 month's data to understand where the economy is going. We 0:09:41.880 --> 0:09:44.400 do aspire to have a rich understanding of private sector 0:09:44.480 --> 0:09:48.240 data market signals. But it's very hard to be Alan 0:09:48.280 --> 0:09:51.720 Greenspan and it's very hard to be Stan Ruckermiller, and 0:09:51.760 --> 0:09:54.520 being a not very good version of those two could 0:09:54.520 --> 0:09:56.439 be quite dangerous. So it's going to be a big 0:09:56.559 --> 0:09:59.079 challenge to be able to do this in a way 0:09:59.320 --> 0:10:04.400 that is very sophisticated and successful, and an additional challenge 0:10:04.440 --> 0:10:10.240 in making policy in a systematic and predictable way when 0:10:10.280 --> 0:10:13.520 you are, for good reasons, trying to draw in more 0:10:13.559 --> 0:10:16.600 private sector insight and more markets insight as well as 0:10:16.800 --> 0:10:18.040 standard macro data. 0:10:18.320 --> 0:10:20.679 Yeah, I guess this gets a little bit how we 0:10:20.720 --> 0:10:23.120 think he's going to get on with people at the FED. 0:10:23.200 --> 0:10:25.960 But I guess the people who are who would be 0:10:26.120 --> 0:10:30.440 concerned about that combination that you talked about. And to 0:10:30.480 --> 0:10:33.120 your point, he doesn't have the background of Valan Greenspan. 0:10:33.120 --> 0:10:35.920 It's easy to be snobby about non economist FED chairs. 0:10:36.000 --> 0:10:39.320 J Powell not done so badly. He's a non economist. 0:10:39.480 --> 0:10:42.480 Christine Legard was also a lawyer like Kevin Walsh. So 0:10:42.520 --> 0:10:45.160 it doesn't seem to be unfortunately for US economists, it 0:10:45.160 --> 0:10:47.960 doesn't seem to necessarily be in a bar to being 0:10:48.000 --> 0:10:51.760 a good FED chair Central Bank governor. But when you're 0:10:51.840 --> 0:10:57.280 pinning a lot on this argument about how a technological 0:10:57.400 --> 0:11:01.280 change is affecting the real economy, is that going to 0:11:01.280 --> 0:11:05.000 give him some persuading to do the FED making that case, 0:11:05.040 --> 0:11:07.640 trying to get people on side with that, when actually 0:11:08.400 --> 0:11:11.120 he's been a bit rude about some of the people 0:11:11.120 --> 0:11:13.079 inside the FED, and he's even talked about the need 0:11:13.120 --> 0:11:16.240 for regime change and breaking some heads and all these 0:11:16.320 --> 0:11:17.040 kind of phrases. 0:11:17.400 --> 0:11:20.760 Yeah, so, certainly as a bit of a repair job 0:11:20.800 --> 0:11:24.680 to do in terms of his internal relationships at the FED, 0:11:24.679 --> 0:11:28.840 which will be important for his success. And you know, 0:11:28.880 --> 0:11:31.360 I think if he's smart, which I know he is, 0:11:31.880 --> 0:11:34.319 and if he has enough slack from the administration, which 0:11:34.360 --> 0:11:38.439 I'm not so sure about he will dial down on 0:11:38.559 --> 0:11:42.640 the MAGA regime change stuff from here on in, because, 0:11:42.679 --> 0:11:45.920 of course, even if you're approaching this from the perspective 0:11:46.000 --> 0:11:49.320 of trying to deliver the several rate cuts of the 0:11:49.360 --> 0:11:52.679 administration is hoping for this year, your ability to do 0:11:52.720 --> 0:11:55.000 that is much greater if you are able to win 0:11:55.080 --> 0:11:58.360 over the if you like the old FOMC, get them 0:11:58.400 --> 0:12:01.760 on side rather than fight French warfare, are the committee 0:12:01.840 --> 0:12:05.240 through the balance of this year. Kevin is somebody who 0:12:05.240 --> 0:12:07.200 has said a lot of rude things about the FED recently. 0:12:07.240 --> 0:12:10.280 He's also someone who has very high EQ and good 0:12:10.360 --> 0:12:14.400 people management skills, and so I could imagine him behind 0:12:14.440 --> 0:12:19.600 closed doors actually being relatively conciliatory and try to build 0:12:19.600 --> 0:12:22.480 bridges with folks. But of course, if he comes in 0:12:22.520 --> 0:12:24.800 and says he's going to fire a third of the staff, 0:12:24.840 --> 0:12:27.320 for instance, as Mickey Bowman is doing on the banking side, 0:12:27.679 --> 0:12:31.720 and has no interest in analytic traditional analytics around Ferbus 0:12:31.720 --> 0:12:34.320 and so forth, that would pit people's backs up and 0:12:34.360 --> 0:12:36.959 make it less likely that they would follow him. Your 0:12:37.000 --> 0:12:39.480 point is on the actual merits of the economic judgment. 0:12:39.920 --> 0:12:42.440 I don't think people on the FED are going to 0:12:43.240 --> 0:12:46.199 be willing to go with a positive productivity shock story 0:12:46.800 --> 0:12:50.360 just on an assertion or on a belief or an 0:12:50.360 --> 0:12:53.719 expectation that this is coming. At the same time, I 0:12:53.800 --> 0:12:56.400 think we are already starting to see certain things in 0:12:56.400 --> 0:13:00.360 the data that starting to point in that direction. The 0:13:00.400 --> 0:13:04.440 FED upgraded its productivity assessment for this year in December, 0:13:04.760 --> 0:13:08.800 when Power essentially acknowledged that the base productivity growth has 0:13:08.840 --> 0:13:13.240 already stepped up in the US. My own analysis suggests 0:13:13.480 --> 0:13:16.440 that productivity this year next year will be again a 0:13:16.440 --> 0:13:18.600 bit higher than the last few years, which were a 0:13:18.600 --> 0:13:21.120 bit higher than the years that went before them. And 0:13:21.160 --> 0:13:25.840 so the question is what's the unbiased estimate. The unbiased estimate, 0:13:26.080 --> 0:13:27.920 in other words, something which is equally likely to be 0:13:27.960 --> 0:13:30.960 wrong on both sides probably does have a step up 0:13:31.000 --> 0:13:33.600 in productivity. Just a question of how hard you want 0:13:33.640 --> 0:13:34.480 to push that theme. 0:13:34.880 --> 0:13:36.760 Yes, And I suspect that's something we'll be coming back 0:13:36.800 --> 0:13:39.240 to on trumponomics, not least because there are even some 0:13:39.280 --> 0:13:42.080 small signs of a pickup in productivity in the UK, 0:13:42.240 --> 0:13:44.400 where it has been dead and varied for really a 0:13:44.400 --> 0:13:46.760 long time. So we were waiting to see if those 0:13:46.760 --> 0:13:49.640 get trampled on in the spring rains. Let's get to 0:13:50.320 --> 0:13:52.760 his approach to the balance sheet, because where he has 0:13:52.880 --> 0:13:57.360 talked about really want to bring in the changes outside 0:13:57.400 --> 0:14:00.520 of the sort of traditional monetary policy, had you set 0:14:00.600 --> 0:14:04.680 interest rate, is in this desire to shrink the balance sheet. 0:14:04.720 --> 0:14:08.200 The Fed famously had its I think its balance sheet 0:14:08.280 --> 0:14:12.040 was less than a trillion dollars before the global financial crisis. 0:14:12.320 --> 0:14:15.520 It peaked at about nine trillion dollars after COVID, and 0:14:15.360 --> 0:14:18.240 it's shrunk a little bit as a result of those 0:14:18.360 --> 0:14:21.960 kind of those sales of bonds that the Fed was holding, 0:14:22.360 --> 0:14:24.680 but it's still roughly seven or eight times what it 0:14:24.800 --> 0:14:29.520 was twenty years ago. That potentially has quite big implications 0:14:29.520 --> 0:14:31.960 not for short term interest rates, but for long term 0:14:32.000 --> 0:14:37.400 interest rate if he aggressively moved to restart the shrinking 0:14:37.520 --> 0:14:40.440 of the Fed balance sheet, because obviously they had stopped 0:14:40.440 --> 0:14:43.240 that quite recently. So how do you see that and 0:14:43.520 --> 0:14:45.800 are you concerned about it? Right? 0:14:46.320 --> 0:14:48.800 Yeah, So, first of all, just for your listeners, it's 0:14:48.800 --> 0:14:51.120 made a bit more progress bringing down the balance sheet 0:14:51.440 --> 0:14:53.000 from the peak around I think, as you said, was 0:14:53.040 --> 0:14:55.240 it nine trillion. We're down about six and a half 0:14:55.240 --> 0:14:59.120 trillion at this point. That's an appreciable reduction, and in 0:14:59.200 --> 0:15:01.720 terms of the ratio of the central bank balance sheet 0:15:01.800 --> 0:15:04.840 to nominal GDP, which is or banking assets, which is 0:15:05.200 --> 0:15:07.920 a sort of a kind of reasonable benchmark. You certainly 0:15:08.000 --> 0:15:11.920 unwound the pandemic expansion in the balance sheet, so that 0:15:11.960 --> 0:15:15.880 past at least has roundtripped. But you're absolutely right that 0:15:16.360 --> 0:15:19.800 if we're looking for one consistent theme across Kevin Walsh's career, 0:15:20.600 --> 0:15:24.840 it's that he favors a smaller, cleaner, and I would 0:15:24.840 --> 0:15:28.880 add humbler central bank balance sheet, meaning that it's not 0:15:29.080 --> 0:15:31.560 just about the size and composition and duration of the 0:15:31.600 --> 0:15:34.480 balance sheet, but it's also about this idea that a 0:15:34.520 --> 0:15:37.840 big central bank balance sheet is a form of big 0:15:37.880 --> 0:15:42.440 government at big footprint of the government sector in markets, 0:15:42.800 --> 0:15:45.360 and that this is unhealthy in lots of ways, some 0:15:45.400 --> 0:15:48.560 of which relate to the encouragement it gives to the 0:15:48.560 --> 0:15:52.120 fiscal authority to run big deficits and debts, but also 0:15:52.200 --> 0:15:55.000 that just you don't want a system where the central 0:15:55.040 --> 0:15:58.680 bank is such a big actor in money markets and 0:15:58.760 --> 0:16:01.920 in financial markets. So I think that is a deep 0:16:02.040 --> 0:16:06.400 seated and sincere conviction on the part of Wash. The 0:16:06.520 --> 0:16:08.800 question is how should we expect that he will look 0:16:08.840 --> 0:16:11.840 to try to reflect that during his tenure as FAT chair. 0:16:12.440 --> 0:16:14.360 I think the idea that Kevin will go out there 0:16:14.400 --> 0:16:17.200 and try to kick off some big QT program fairly 0:16:17.240 --> 0:16:21.560 soon is laughably improbable. He is somebody who is quite 0:16:21.640 --> 0:16:25.120 savvy and understands full well that his greatest point of 0:16:25.200 --> 0:16:29.160 vulnerability is his past comments about the balance sheet. And 0:16:29.200 --> 0:16:31.600 if he says anything that sounds too hawkish on the 0:16:31.600 --> 0:16:34.800 balance sheet or suggests that he might be keen kick 0:16:34.840 --> 0:16:37.640 on with QT again fairly soon, he writ is to 0:16:37.680 --> 0:16:40.480 blow up in terms of a spike in bond yield. 0:16:40.880 --> 0:16:43.640 That would not only be a big hit to the 0:16:43.640 --> 0:16:46.000 start of his career as VET chair, he would also 0:16:46.040 --> 0:16:50.080 blow up his relationship with Secretary Vesant and President Trump. 0:16:50.280 --> 0:16:52.880 So this is the last thing that Kevin wants. I 0:16:52.920 --> 0:16:55.520 think Kevin will as soon as he starts speaking, he 0:16:55.560 --> 0:16:58.880 will signal that he's going to be very pragmatic on 0:16:58.920 --> 0:17:02.160 the balance sheet, very in terms of what he may 0:17:02.480 --> 0:17:06.440 try to do on the balance sheet. One mechanism for 0:17:06.600 --> 0:17:09.560 signaling that to the market is his idea of a 0:17:09.600 --> 0:17:15.000 Fed Treasury accord that would facilitate closer institutional cooperation between 0:17:15.080 --> 0:17:17.240 the Fed and the Treasury. Now the mention of Fed 0:17:17.240 --> 0:17:21.320 Treasury accords makes some as nervous as to exactly how 0:17:21.359 --> 0:17:25.439 this would affect contritionan traditional conceptions of central bank independence. 0:17:25.840 --> 0:17:28.199 But Kevin will argue that, look, the central Bank can 0:17:28.200 --> 0:17:31.199 be independent but still coordinate the more effective or cooperate 0:17:31.240 --> 0:17:33.960 in a more effective way with the Treasury in the 0:17:34.000 --> 0:17:36.360 here and now. That would be very much I think 0:17:36.440 --> 0:17:40.119 about making sure that any balance sheet plans on the 0:17:40.160 --> 0:17:43.640 Fed side were consistent with plans on the Treasury's debt 0:17:43.680 --> 0:17:46.120 management side, if you like a little bit of sort 0:17:46.119 --> 0:17:49.119 of soft coordination there. But I think the signal to 0:17:49.200 --> 0:17:53.600 market is intended to be that I Kevin Walsh and 0:17:53.800 --> 0:17:57.520 giving Scott Besson a soft veto, not a hard veto, 0:17:57.640 --> 0:18:01.119 but a soft veto on any QT plans. So you 0:18:01.119 --> 0:18:03.720 can all relax because you may not trust me, but 0:18:03.800 --> 0:18:06.400 you know full well that Scott doesn't want higher yields 0:18:06.440 --> 0:18:07.919 and higher mortgage rates. 0:18:25.680 --> 0:18:27.280 Just to get into that whether you because you are 0:18:27.320 --> 0:18:29.960 such a sort of long term observer and thinker about 0:18:30.000 --> 0:18:32.399 this particular bit of the market and the kind of 0:18:32.440 --> 0:18:36.280 interaction of markets with policy of the Fed, you could 0:18:36.280 --> 0:18:39.000 imagine quite a lot of people in the financial markets 0:18:39.359 --> 0:18:42.480 would think, yeah, big government's bad. We don't like FED 0:18:42.480 --> 0:18:44.520 that gets in the way and gets super involved in 0:18:44.520 --> 0:18:47.439 lots of different things. On the other hand, some of 0:18:47.480 --> 0:18:49.960 the people who have talked to me who've been most 0:18:50.040 --> 0:18:53.919 concerned about shrinking the FED balance sheet faster have been 0:18:54.000 --> 0:18:56.920 people who look at the short term liquidity of treasury 0:18:57.000 --> 0:19:00.000 markets and the repurchase market. That's kind of very short 0:19:00.160 --> 0:19:03.399 term equidity that banks need to keep the financial system 0:19:03.400 --> 0:19:06.399 ticking over, and a worried that if you have, over 0:19:06.520 --> 0:19:09.199 time quite a significant reduction in the balance sheet that 0:19:09.200 --> 0:19:12.679 could actually have unexpected consequences that we don't really understand 0:19:12.760 --> 0:19:15.200 for liquidity in day to day markets. Do you agree 0:19:15.240 --> 0:19:15.439 with that? 0:19:16.000 --> 0:19:18.320 I certainly think if it was mishandled, it would have 0:19:18.400 --> 0:19:22.520 very significant consequences for money markets as well as potentially 0:19:22.760 --> 0:19:25.560 the functioning of the treasure debt market itself. That's precisely 0:19:25.640 --> 0:19:28.639 why wash is going to be extremely careful here. So 0:19:28.840 --> 0:19:30.399 if you forgive me for just being a little bit 0:19:30.560 --> 0:19:35.280 analytic for a second step, Kevin understands full well that 0:19:35.880 --> 0:19:41.640 the size of the fair balance sheet is dictated by 0:19:41.800 --> 0:19:46.840 the amount of reserves that banks want to hold for 0:19:46.960 --> 0:19:53.600 any given chosen operating framework, that the Central Bank operates with. 0:19:54.480 --> 0:19:58.440 So the big change from the pre financial crisis period 0:19:58.560 --> 0:20:00.960 to the present is that the FED moved from what 0:20:01.080 --> 0:20:05.040 was called a scarce reserves system to what's called an 0:20:05.080 --> 0:20:10.679 ample reserves system. In theory, the WASHPED could try to 0:20:10.960 --> 0:20:15.880 overtime move back towards a scarce reserve system, that would 0:20:15.880 --> 0:20:21.200 be extremely difficult to implement operationally, very challenging. It would 0:20:21.240 --> 0:20:24.000 be a massive headache, and it would also involve the 0:20:24.119 --> 0:20:28.640 kind of FED portfolio shrinkage over time that would likely 0:20:28.680 --> 0:20:33.000 put substantial upward pressure on longer term bond yields in 0:20:33.040 --> 0:20:36.119 a way that would be very much antithetical to what 0:20:36.240 --> 0:20:38.760 the Treasury and the White House is trying to achieve. 0:20:39.880 --> 0:20:42.879 We think that the FED itself would not go along 0:20:42.920 --> 0:20:47.560 with that, that the vast majority of the FOMC has 0:20:47.600 --> 0:20:51.640 a sort of settled preference for the ample reserves system. 0:20:52.040 --> 0:20:55.520 So our call is that WASH will not move off 0:20:55.600 --> 0:20:59.119 the ample reserve system towards the scarce reserve system. Once 0:20:59.240 --> 0:21:01.640 you've settled that you're running an ample reserve system, you're 0:21:01.680 --> 0:21:04.920 going to have a big balance sheet period. Now question 0:21:05.320 --> 0:21:08.119 how big. Let's determine by the second part of the 0:21:08.160 --> 0:21:11.000 formula I gave you how many reserves do the banks 0:21:11.040 --> 0:21:15.720 want to hold for a given operating framework. Now that 0:21:16.400 --> 0:21:20.920 may be sensitive to the regulatory regime. What I think 0:21:21.200 --> 0:21:25.560 is potentially going to happen here is that Wash, in 0:21:25.720 --> 0:21:29.840 concert with the Treasury and the other banking regulatory agencies 0:21:29.880 --> 0:21:33.760 in the US, will be pushing hard on banking deregulation. 0:21:34.920 --> 0:21:38.280 The FAD will also, Underwash, be pushing hard on easing 0:21:38.400 --> 0:21:41.280 up on banking supervision, which is the sort of the 0:21:41.320 --> 0:21:43.520 implementation of the rules, if you like, rather than the 0:21:43.600 --> 0:21:49.199 rules themselves. And the hope would be that as a 0:21:49.240 --> 0:21:54.280 result of extensive banking deregulation that makes it cheaper in 0:21:54.359 --> 0:22:00.760 capital terms and liquidity terms to hold government paper, banks 0:22:00.800 --> 0:22:04.520 will choose to hold a bit more government debt, including 0:22:04.600 --> 0:22:08.960 treasury bills, and a bit less by way of bed reserves, 0:22:09.800 --> 0:22:14.600 to the extent that banking deregulation means that the bank's 0:22:14.640 --> 0:22:19.320 desire less reserves. That would then allow Kevin to reduce 0:22:19.359 --> 0:22:23.800 the balance sheet some without stressing money markets. But if 0:22:23.800 --> 0:22:28.240 he tried to reduce the balance sheet today without changing 0:22:28.280 --> 0:22:32.320 the framework or banks demand for reserves in the framework, 0:22:32.720 --> 0:22:35.080 all that would happen is you would have an immediate 0:22:35.119 --> 0:22:37.600 return to money market stress of the kind we saw 0:22:37.880 --> 0:22:40.720 in October and December, and he'd be back in balance 0:22:40.760 --> 0:22:43.840 sheet expansion again within a week. He knows that, and 0:22:43.840 --> 0:22:45.040 that's why it's not going to happen. 0:22:45.359 --> 0:22:47.800