Between 2008 and 2026, understanding central banks has arguably been one of the most valuable investment skills, at least for those who have tried to time their investments correctly. Now, in May, Trump has appointed Kevin Warsh as the new Chair of the FED, which appears to be a complete reversal of the philosophy practiced by central banks between 2008 and 2026.
It is interesting that the forum has not yet addressed this news in its own thread, even though this could have a very significant impact on how markets function.
Central Bank Philosophy:
Kevin Warsh is clearly less Keynesian, or even anti-Keynesian, in his philosophy compared to his predecessors. Warsh represents more of a monetarist school of thought, where central banks are not intended to take a dominant role in the markets; instead, in the monetarist school, the central bank’s task is limited to keeping inflation stable. The FED certainly has a dual mandate to also look after employment, but at least for the moment, this goal seems secondary due to the current favorable employment situation.
Warsh’s Keynesian-leaning predecessors learned, at the latest after the 2008 financial crisis, to act quickly, proactively, and by strongly supporting the market financially as soon as the markets or the stock exchange showed even the slightest signs of gloom. With Warsh leading the FED, it is to be expected that the FED will not stimulate the market in response to stock market volatility unless there are strong signs that this volatility is spreading to the broader market and clearly affecting inflation or employment.
Previous chairs have reacted if there was even a model-based forecast that inflation or employment might change, but Warsh’s position seems to be that inflation or employment should be allowed to change first, and only then should a central bank intervention occur.
Change in Philosophical Direction:
I see this change in philosophy as partly a positive direction because, since the financial crisis, the role of central banks in the economy has, in my opinion, grown too large. This has meant, for example, that bad economic news has often counterintuitively led to a rise in stock prices—and vice versa. The stock market has expected the central bank to react to economic news and has reacted by countering the central bank’s intervention. This transformation of good economic news into bad stock market news is, in my opinion, truly perverse, although it is, of course, rational and supported by game theory from the market’s perspective.
Although this expected change in philosophy brought by Warsh might be “healing” for the markets, at the same time I also see a major risk of a large market correction. If the market sentiment is allowed to drift too far into the negative, it requires very strong intervention from central banks before the sentiment can be turned positive. If the FED’s “fuse” becomes longer, then more cards have time to collapse in the house of cards, and the momentum for a larger crash increases.
Timing of the Change:
The philosophical change in the FED Chair comes at an interesting time, where valuations of AI companies in particular are high on the stock exchange. For example, SpaceX just went public at a valuation 100 times its revenue.
Whatever one’s opinion on the state of the stock market, it is clear that there is currently a desire in the markets to speculate on the future and take large positions on future growth figures, while the stock market is heavily leveraged with debt. In Warsh’s monetarist philosophy, the market is allowed to do so, but it must bear the risk of its own decisions itself. And that is indeed how capitalism should work. Investors must bear the risk of their investments themselves, and bearing that risk is not the responsibility of the central bank or the taxpayers.
The change in philosophy could significantly affect the operations of shadow banks (private credit), which have financed the construction of AI infrastructure with about 500 billion dollars. I personally consider this private credit sector an important pillar of the house of cards, the collapse of which has a clear risk of leading to a broader market rout. Under previous chairs, I would have considered it a certainty that the shadow banks would be bailed out, but in the era of Warsh, it is hard to believe in that just yet.
My view is that Kevin Warsh’s philosophy will not accept bailing out these private credit investments if the AI investments turn sour—or at least, Warsh will not react to problems until there is a clear risk that the problems will spill over into the broader economy and significantly affect inflation and employment. It may even be that the risks are allowed to spread to the wider market before the FED reacts.
During the autumn, we will see how and how quickly Warsh reacts to potential cracks and negative economic news. In any case, my guess is that the FED will not react to stock market declines in the same way as it did under his predecessors, and I intend to keep my “fuse” for buying longer than before.
Purpose of the Thread - Tracking the Philosophy:
I thought I would collect the FED’s statements here throughout the autumn and track what kind of person Kevin Warsh is. For now, the text above is still largely speculation. So, let’s follow how the situation progresses from here, but feel free to speculate yourselves, fellow forum members, on what is going to happen.