Kevin Warsh faces an immediate test as he assumes the chairmanship at the US Federal Reserve: navigating the tension between higher interest rates and political pressure from President Donald Trump.
How he steers the US central bank's monetary policy in the face of White House pressure could determine what kind of Fed chair he will be for markets in the US and in the Gulf.
“That distinction matters more in the Gulf than in many other regions because Gulf economies do not simply watch the Fed. They import a large part of US monetary policy through dollar pegs, bank funding costs and dollar liquidity,” said Ahmed Azzam, head of market research at Equiti Group.
Because its dirham is pegged to the US dollar, the UAE Central Bank this year has kept its base rate unchanged at 3.65 per cent. The base rate influences the Emirates Interbank Offered Rate (Eibor) that is used for mortgages, car loans and corporate borrowing.
One of the biggest questions facing Kevin Warsh is if an eventual rate cut (when conditions allow) will be perceived as bowing to White House pressure.
“For Gulf markets, that is the line between relief and risk,” Mr Azzam said.
Iran war complicates outlook
Mr Warsh enters the Fed as the Iran war adds increasing uncertainty over the US economic outlook.
“This kind of uncertainty makes economic decision-making, which even in normal times is hard enough, even more difficult,” said David Wilcox, senior fellow at the Peterson Institute for International Economics and director of US economic research at Bloomberg Economics.
Rising energy costs associated with supply chain disruptions due to the Iran war are biting into the US economy, with government data this week showing wholesale inflation and consumer prices accelerating at their fastest pace in years.
A higher-for-longer rate outlook is unlikely to satisfy Mr Trump, who could attack Mr Warsh in the same manner in which he has relentlessly attacked outgoing chair Jerome Powell. For Mr Warsh, who will serve a 14-year term as Fed governor and a concurrent four-year term as Fed chair, this will quickly determine his credibility with markets.
The Iran war and political pressure are not the only challenges facing Mr Warsh. He will also inherit a rate-setting committee that is positioning itself against ill-guided rate cuts. While Mr Warsh will steer the agenda and discussion on monetary policy, he still holds just one vote out of 12 members.
“It's hard to see how he can reconcile those three considerations,” said Mr Wilcox, who formerly led the Fed's research and statistics division.
Entering the Warsh era
Mr Warsh, who previously served as Fed governor from 2006-2011, will re-enter the US central bank with his own vision for its role in the financial system.
One major change will be the Fed's balance sheet, which peaked at $9 trillion in 2022. The Fed purchased millions of dollars in assets like mortgage-backed securities and Treasuries to support the financial system during the global financial system and Covid-19 pandemic in a process known as quantitative easing.
The balance sheet still sits at a historically high $6.7 trillion and Mr Warsh argues that measures like QE threaten the Fed's independence.
However, moving too quickly risks disruption in financial markets that will be in Abu Dhabi, Dubai and Riyadh.
“If he gets it wrong, the region may hear about Fed cuts … in the headlines while still facing expensive money in practice,” Mr Azzam said.
Mr Warsh has also suggested working more closely with the Treasury on the balance sheet and swap lines, and has argued for fewer press conferences and speeches from Fed officials.
Powell's shadow
All of these factors will weigh heavily on Mr Warsh as he takes control of the most globally significant central bank. While Mr Powell was a popular figure on Capitol Hill and enjoyed reverence from global markets, Mr Warsh faces an uphill challenge.
Gary Richardson, who was the first official historian of the Federal Reserve system, said the question facing Mr Warsh is how he will protect the institution and his legacy.
“The point of this job is to have a legacy,” Mr Richardson said.
Questions over Fed independence dominated the final year of Mr Powell's term as chair. While that term is up, Mr Powell said he would continue serving the remaining two years of his term as a Fed governor, arguing doing so would protect the institution amid a legal battle between him and the Trump administration.
Despite questions of whether Mr Warsh will be a “sock puppet”, the former Fed governor will enter the central bank with the credibility of someone who understands the institution, likely calming nerves that he would easily cave to the President's demands.
“Trump seems to want to have a lot of people in the government who are kind of subservient to him,” Mr Richardson said.
“Kevin Warsh is not going to be that.”
