The Federal Reserve is undergoing significant changes under the leadership of its new chair, Kevin Warsh. In a speech at a conference in Bangkok, Warsh announced his intention to focus on the bank's operations beyond monetary policy, including supervision, regulation, and payments. These areas account for about three-quarters of the Fed's staff, and Warsh plans to spend the next three months immersing himself in these functions.
Warsh's approach contrasts with the Fed's traditional role of setting and communicating future credit prices. He aims to reduce the market's reliance on the Fed for guidance, a shift that aligns with the market's growing independence. This independence is particularly evident in the bond market, which has expanded to the point where it operates more autonomously than in the past.
The bond market's size, roughly $188 trillion globally, has surpassed the global banking system's assets of $190 trillion, with much of the banking system's holdings being bonds. This shift has led to a situation where the bond market is making its own decisions rather than waiting for the Fed to set rates. The result is a dynamic where the price of credit is no longer solely determined by the Fed, affecting broader economic outcomes.
Warsh's vision echoes the famous 'Punchbowl Speech' by former Fed Chair William McChesney Martin, who emphasized the Fed's role as a chaperone rather than a participant in market exuberance. While Warsh may not see the Fed in the same light, his goal of fostering market independence is being realized, though the outcomes may not always align with his preferences.