Warsh politics starts inside the Fed

 

The most important political issue for Fed Chairman Warsh is not working with Congress or keeping President Trump happy, but working on the politics within the Fed. While not like the Volcker period, the current problem is the uptick in no (dissents) to yes votes during the last year of the Powell era. While dissent does not make the Fed ineffective, it creates more market uncertainty. A high dissent ratio indicates disagreement over policy direction, which will spill over into market thinking. Is consensus necessary? No, but it is helpful, especially if there is a change in policy direction.

Follow the equity risk premium

 

There should be an equity risk premium over bonds. Equity is riskier than bonds, yet the current market does not suggest this. The bond market has disconnected from equities. One can always say that bondholders are pessimists relative to equity optimists, yet there is more going on than just behavior. 

Bonds are pricing stagflation, while equities, through cap-weighted indices, are pricing an AI productivity revolution. Perhaps both can be right, but that does not bode well for holding equity in traditional companies. 

The politics of the Fed run through Congress

 

This is an interesting chart on the politics of the Fed. Clearly, Powell is a political animal. There is nothing wrong with being political. It is important to maintain good communication with politicians to ensure they understand the Fed's role and mission. One of the key Fed battles has always been the level of oversight from Congress. (I was involved in that fight in the 1980's when consulting for the GAO on primary dealer oversight. Getting data from the Fed was an ordeal.)

Powell needs to limit interference from the executive branch and ensure there is limited oversight from Congress. Independence takes work. 

So bonds are not the solution?

The chart from Nicolas Rabener of Finominal compares the drawdown from bonds versus managed futures. If you ask most investors, they would say that a managed futures fund is riskier, yet when you look at the long history of bonds, it does not look attractive. There can be drawdowns for decades. It is unlikely the 10-year will get out of this drawdown in time in the near future. Of course, it is critical to think about upside and what a bond drawdown means.