Even after recent economic data from January on consumer prices and the labor market, investors still largely expect the Federal Reserve to lower interest rates two more times this year, bringing the federal funds rate into a range of 3% to 3.25% (as of Feb. 13). The cuts are expected in June and September. Naturally, there is a good amount of dispute regarding this outlook, in both directions.
In fact, one prominent billionaire investor publicly said he thinks the market is wrong and that the Fed will conduct "substantially more than two cuts" this year. Here's why.
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Don't underestimate the new incoming Fed Chair, Kevin Warsh
For months leading up to President Donald Trump's selection of Kevin Warsh as the new Fed chair, who will start in May, investors were concerned that the next Fed chair might be too eager to please the President. That explained some of the push into precious metals like gold and silver. However, the market seemed to breathe a sigh of relief when Trump picked Warsh.
Warsh has a long history of working on Wall Street for the famed investor Stanley Druckenmiller, and was one of the youngest-ever members of the Federal Reserve's Board of Governors, serving from 2006 to 2011. Still, the billionaire investor David Einhorn, who runs Greenlight Capital, believes Warsh is likely to try and cut interest rates in most scenarios.
"If we have 4% or 5% inflation, sure, then he won't be able to persuade people, but otherwise he's going to argue productivity," Einhorn told CNBC recently, referring to the idea that a surge in productivity will allow businesses to be more efficient and therefore grow without increasing prices that will funnel down to the economy. Einhorn also said he believes Warsh will push to lower rates "even if the economy is running hot."
To play this bet, Einhorn's fund owns gold and futures on the secured overnight financing rate (SOFR), which is heavily influenced by the federal funds rate that the Fed controls.
Interestingly, Warsh has been hawkish in the past, particularly during his stint as a Fed governor, when he regularly worried more about inflation than the labor market. If Warsh were to take this approach today, he would likely not be a proponent of rate cuts because inflation remains above the Fed's preferred 2% target, while the unemployment rate just declined to 4.3%. The devil lies in the details behind these numbers, of course.
Can Warsh be a hawk and please Trump at the same time?
I don't believe it's illogical to expect that Warsh will be an advocate for rate cuts, barring a scenario in which inflation surges. Trump has been quite vocal about his desire for lower interest rates, and he hasn't made current Fed Chair Jerome Powell's job easy. It's hard to believe Trump would have picked Warsh, had he not given at least some reassurances that he plans to try and persuade the rate-setting Federal Open Market Committee (FOMC) to lower rates.
But is it possible that Warsh could appease Trump while also being hawkish? Yes, in fact. Warsh, as well as Treasury Secretary Scott Bessent, have expressed a desire to shrink the Fed's massive balance sheet. Under Powell, the Fed ballooned the Fed's balance sheet, largely in response to the pandemic. Since then, the Fed has used quantitative tightening (QT) to shrink the balance sheet, though those efforts ended at the end of last year.
US Total Assets Held by All Federal Reserve Banks data by YCharts
So, Warsh could, in theory, lower interest rates while also deploying QT. However, QT can be difficult to control at times and can drain reserves from the economy too quickly, creating issues for short-term rates, as in 2019, when the Fed had to step in and inject capital. In fact, the Fed recently stopped QT because of concerns about this very issue.
The big thing investors should understand is that it's not all about interest rates. How the Fed approaches the balance sheet could be equally as important for markets. Keep an eye on both.
