The Fed’s Course Under a New Chair

Summary

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Thoughts on the Market

Episode: The Fed’s Course Under a New Chair

Date: February 5, 2026
Hosts: Matthew Hornbach (Global Head of MacroStrategy), Michael Gapen (Chief US Economist)

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Main Theme

This episode examines the outcomes and market implications of the first Federal Open Market Committee (FOMC) meeting of 2026, focusing on the Fed’s current monetary policy stance, upcoming leadership changes, and the market’s reaction to President’s nomination of Kevin Warsh as the next Fed chair.

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Key Discussion Points & Insights

1. Takeaways from the January 2026 FOMC Meeting

• Policy Stance:
  • The market widely expected a pause in rate actions at this meeting.
  • The focus was on whether the pause would be “hawkish” (implying potential future tightening) or “dovish” (implying potential future easing).
  • The Fed’s communication signaled a dovish hold, maintaining an easing bias.
    • “It was clear they were going to pause. The question was would they pause or would they be on pause? …it was more of a dovish hold.” (Michael Gapen, 00:34)
  • Most data showed inflation under control and stable employment, supporting the current approach.

2. Chair Powell’s Future and DOJ Subpoena

• Uncertainty Over Powell’s Tenure:
  • Powell was noncommittal about his plans after his term as chair ends in May; he could remain as governor through 2028.
  • The Department of Justice (DOJ) issuing a subpoena complicates his calculus, possibly making it more likely he stays to address ongoing matters.
    • “He has his own reasons and that's fine. And I do think the recent subpoena by the DOJ has changed the calculus...it makes it more likely that he stays around.” (Michael Gapen, 02:07)
• Unclear Committee Composition:
  • The administration has nominated Kevin Warsh, but it's unclear whether he would replace Powell or another member, such as Stephen Myron.
  • Ongoing legal and political questions (including a Supreme Court case about removing Lisa Cook) add uncertainty to the forthcoming FOMC roster.

3. Implications of Kevin Warsh’s Nomination

• Outlook for Policy Change:
  • Warsh’s previous public remarks suggest he is broadly aligned with the current mainstream on rates—no immediate or dramatic change expected in the FOMC’s reaction function.
    • “His previous public remarks don't suggest his views on interest rate policy are substantively outside the mainstream… So we think, at least in the near term, the reaction function won't change.” (Michael Gapen, 03:57)
• Consensus-Building Nature of FOMC:
  • The Fed chair’s real influence lies in building consensus; Warsh would need broad support to alter the committee’s direction significantly.
• Balance Sheet Views:
  • Warsh is notably more hawkish on the Fed’s balance sheet, describing it as “bloated” and distortionary.
    • Reducing the balance sheet would be complex, requiring coordination with Treasury and possibly regulatory changes.
    • Any significant change here would take time—“it'll take study, it'll take patience”—and isn’t likely right away.
  • “If there is a substantive change in Fed policy going forward, it could be there on the balance sheet.” (Michael Gapen, 03:57)

4. Market Reactions to Leadership Change

• Direct Market Impact:
  • Traditional markets (interest rates, FX) reacted little; most movement occurred in prediction markets.
    • “The markets that moved the most were not the traditional…markets like interest rates or FX. The markets that moved the most were the prediction markets...” (Matthew Hornbach, 07:07)
• Communication Policy’s Role:
  • Warsh is viewed as favoring less communication from the Fed—a shift from recent policy of extensive guidance.
    • This could create more uncertainty and volatility in rates/currencies if markets need to price in more unknowns.
    • “If there is some kind of a retrenchment from the type of over-communication...that could create a bit more volatility.” (Matthew Hornbach, 07:07)
  • Investors could demand higher risk premiums, potentially resulting in a steeper Treasury yield curve.
• US vs. International Comparisons:
  • The Fed generally avoids surprising markets, unlike central banks such as the Swiss National Bank or Reserve Bank of Australia. Any change moving toward less forward guidance would be notable.
    • “The Fed has been one of the central banks that does not like to surprise the markets…” (Matthew Hornbach, 07:07)

5. Looking Ahead

• Market Awaiting More Data:
  • The next FOMC meeting (March 2026) will clarify whether the Fed will extend its pause or shift policy.
    • “We'll just have to wait between now and then to see if the Fed is on hold for a longer period of time or whether or not the data convince them to move as soon as the March meeting.” (Matthew Hornbach, ~08:22)

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Timestamps for Important Segments

• 00:34: Overview of FOMC’s policy stance and “dovish hold.”
• 02:07: Discussion about Powell’s future, DOJ subpoena, and committee changes.
• 03:57: Analysis of Kevin Warsh’s nomination and outlook for Fed policy/balance sheet.
• 07:07: Breakdown of market reaction to Warsh nomination and potential implications of communication changes.
• ~08:22: Anticipation of March FOMC meeting and data dependency.

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Notable Quotes

• “It was clear they were going to pause. The question was would they pause or would they be on pause? …it was more of a dovish hold.”
  — Michael Gapen (00:34)

• “I do think the recent subpoena by the DOJ has changed the calculus… it makes it more likely that he stays around.”
  — Michael Gapen (02:07)

• “His previous public remarks don't suggest his views on interest rate policy are substantively outside the mainstream… So we think, at least in the near term, the reaction function won't change.”
  — Michael Gapen (03:57)

• “If there is a substantive change in Fed policy going forward, it could be there on the balance sheet.”
  — Michael Gapen (03:57)

• “The markets that moved the most were not the traditional…markets like interest rates or FX. The markets that moved the most were the prediction markets...”
  — Matthew Hornbach (07:07)

• “If there is some kind of a retrenchment from the type of over-communication...that could create a bit more volatility.”
  — Matthew Hornbach (07:07)

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Conclusion

This episode succinctly explored the FOMC’s current direction, the uncertainties surrounding its leadership transition, and how these intersect with market expectations. The consensus is that, despite headline changes, the core of monetary policy should remain steady in the near term—any meaningful shifts would likely come from changes in balance sheet policy or communication strategy over time. Market participants are advised to watch for signals at the March 2026 FOMC meeting, as the evolving Fed composition takes center stage.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Matthew Hornbach, global head of MacroStrategy.

[B]

And I'm Michael Gapen, Morgan Stanley's chief US economist.

[A]

Today we'll be talking about the Federal Open Market Committee meeting that occurred last week. It's Thursday, February 5th at 8:30am in New York. So, Mike, last week we had the first Federal Open Market Committee meeting of 2026. What were your general impressions from the meeting and how did it compare to what you had thought going in?

[B]

Well, Matt, I think that the main question for markets was how hawkish a hold or how dovish a hold would this be. As you know, it was widely expected the Fed would be on hold. The incoming data had been fairly solid, inflation wasn't all that concerning, and most of the employment data suggested things had stabilized. So it was clear they were going to pause. The question was would they pause or would they be on pause? Right. And in our view it was more of a dovish hold. And by that it suggests to us, or they suggested to us, I should say, that they still have an easing bias and rates should generally move lower over time. So that really was the key takeaway for me. Would they signal a prolonged pause and perhaps suggest that they might be done with the easing cycle, or would they say, yes, we've stopped for now, but we still expect to cut rates later perhaps when inflation comes down and therefore kind of retain a dovish bias or an easing bias in the policy rate path. So to me, that was the main takeaway.

[A]

Of course, as we all know, there are supposed to be some personnel changes on the committee this year, and Chair Powell was asked several questions to try to get at the future of this committee and what he himself was going to do personally. What was your impression of his response and what were the takeaways from that part of the press conference?

[B]

Well, clearly he's been reluctant to say pre announce what he may do when his term as chair ends in May, but his term as a governor extends into 2028, so he has options. He could leave normally that's what what happens. But he could also stay. And he's never really made his intentions clear on that part, I think for maybe personal or professional reasons. But he has his own reasons and that's fine. And I do think the recent subpoena by the DOJ has changed the calculus in that at least my own view is that it makes it more likely that he stays around. It may be easier for him to act in response to that subpoena by being on staff It's a request for additional information. He needs access to that information. I think you could construct a reasonable scenario under which, well, I have to see this through, therefore I may stay around. But maybe he hasn't come to that conclusion yet. And then stepping back, it just complicates the whole picture in the sense that we now know the administration has put forward Kevin Warsh as the new Fed chair. Will he be replacing the seat that Jay Powell currently sits in? Will he be replacing the seat that Stephen Myron is sitting in? So, yes, we have a new name being put forward, but it's not exactly clear where that slot will be and what the composition of the committee will look like.

[A]

Well, you beat me to the punch on mentioning Kevin Warsh.

[B]

I kind of assumed that's where you.

[A]

Were going is going to be my next question. I'm curious as to what you think that means for Fed policy later this year, if anything, and what it might mean more medium term.

[B]

First of all, congratulations to Mr. Warsh on the appointment. In terms of what we think it means for the outlook for the Fed's reaction function and interest rate policy, we doubt that there will be a material change in the Fed's reaction function. His previous public remarks don't suggest his views on interest rate policy are substantively outside the mainstream, or at least certainly the collective that's already in the fomc. Some people would prefer not to ease. The majority of the committee still sees a couple more rate cuts ahead of them. Warsh is generally aligned with that, given his public remarks. But then also all the Reserve bank presidents have been renominated. There's an ongoing Supreme Court case about the ability of the administration to fire Lisa Cook. If that is not successful, then Kevin Warsh will arrive in an FOMC where there's 16 other people who all get a say. So the chair's primary responsibility is to build a consensus, to herd the cats, so to speak, to communicate to markets and communicate to the public. So if Mr. Warsh wanted to deviate substantially from where the committee was, he would have to build a consensus to do that. So we think, at least in the near term, the reaction function won't change. It'll be driven by the data, whether the labor market holds up, whether inflation decelerates as expected. So we don't look for material change. Now, you also asked about the medium term. I do think where his views differ, at least with respect to current Fed policy, is on the size of the Fed's balance sheet and its footprint in financial markets. So he has argued over time for a much smaller balance sheet. He's called the Fed's balance sheet bloated. He has said that it creates distortions in markets which mean interest rates could be higher than they otherwise would be. And so I think if there is a substantive change in Fed policy going forward, it could be there on the balance sheet. But what I would just say on that is it'll likely take a lot of coordination with Treasury. It will likely take changes in rules, regulations, the supervisory landscape. Because if you want to reduce the balance sheet further without creating volatility in financial markets, you have to find a way to reduce bank demand for reserves. So this will take time, It'll take study, it'll take patience. I wouldn't look for big material changes right out of the box. So Matt, what I'd like to do is if I could flip it back to you. Warsh was certainly one of the expected candidates. Right. So his name is not surprised. But as we knew financial markets, one day we're thinking it'd be one candidate, the next day I'd be thinking it was somebody else. How did you see markets reacting to the announcement of Mr. Warsh for the next Fed share and then maybe put that in context of where market were coming out of the last FOMC meeting?

[A]

Yeah, so the markets that moved the most were not the traditional, very large macro markets like the interest rate marketplace or the foreign exchange market. The markets that moved the most were the prediction markets, these newer markets that offer investors the ability to wager on different outcomes for a whole variety of of events around the world. But when it comes to the implications of a Kevin Warsh led Fed for the bigger macro markets like interest rates and currencies, the question really comes down to how if the Fed's balance sheet policies are going to take a while to implement, those are not going to have an immediate effect, at least not an effect that is easily seen with the human eye. But it's other types of policy change. In terms of his communication policy. For example, one of the points that you raised in your recent note, Mike, was how Kevin Warsh favored less communication than perhaps some of the recent federal open market committees had with the public. And so if there is some kind of a retrenchment from the type of over communication to the marketplace from either committee members or non voters, that could create a bit more volatility in the marketplace. Of course, the Fed has been one of the central banks that does not like to surprise the markets in terms of its monetary policy making. And so that contrasts with other central banks in the G10. For example, the Swiss national bank tends to surprise quite a lot. The Reserve bank of Australia tends to surprise markets more often certainly than the Fed does. So to the extent that there's some change in communication strategy going forward, that could lead to more volatile interest rate in currency markets and that then could cause investors to demand more risk premium to invest in those markets. If you previously were comfortable owning a longer duration treasury security because you felt very comfortable with the future path of Fed policy, then a Kevin Warsh led Fed, if it decides to change the communication strategy, could naturally lead investors to demand more more risk premium in their investments. And that of course would lead to a steeper U.S. treasury curve, all else equal. So that would be one of the main effects that I could see happen in markets as a result of some potential changes that the Fed may consider going forward. So Mike, with that said, this was the first FOMC meeting of the year and the next meeting arrives in March. I guess we'll just have to wait between now and then to see if the Fed is on hold for a longer period of time or whether or not the data convince them to move as soon as the March meeting. Thanks for taking time to talk, Mike. Great speaking with you, Matt, and thanks for listening. If you enjoy thoughts on the market, please leave us A review wherever you listen and share the podcast with a friend or colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.