Kevin Warsh, President Donald Trump's nominee for Federal Reserve chair, told senators during his confirmation hearing that he wants the central bank to adopt a new methodology for measuring inflation—one that could ultimately prove hawkish rather than dovish as he anticipates.
Market Context
The comments came as markets continue processing expectations for monetary policy under a potential Warsh-led Fed. The current Federal Reserve targets core PCE—the price index for personal consumption expenditures excluding volatile food and energy components—as its primary inflation gauge. This measure currently sits at 3%, according to Bank of America data cited in the hearing.
Analysis
Warsh advocated during Tuesday's Senate Banking Committee hearing for what he called "trimmed averages"—a method that removes extreme price movements, whether spikes or drops, when calculating underlying inflation. His stated goal is to isolate generalized price changes from one-off shocks caused by geopolitical events or specific commodity moves.
"What I'm most interested in is: What's the underlying inflation rate? Not: What's the one-time change in prices because of a change in geopolitics or change in beef?" Warsh said, according to testimony reviewed by TradeBytes.
However, Bank of America economist Aditya Bhave cautioned Wednesday that this approach may backfire. The irony, Bhave explained, is that while energy and food shocks get trimmed out under Warsh's preferred method, those same shocks could prevent other items from being trimmed—effectively raising the trimmed mean compared to a scenario without such volatility.
"Even if these shocks get trimmed out, they might still raise the trimmed mean by preventing other shocks from getting trimmed," Bhave wrote in a note to clients. "This is ironic because Warsh also argued yesterday for looking through one-off, supply-driven price increases."
Key Numbers
- Core PCE currently sits at 3%, according to Bank of America data
- Trimmed-mean 12-month inflation gauge would have shown mean of 2.3% and median of 2.8% as of February under Warsh's preferred methodology
- BofA's trimmed-median gauge ran higher than core PCE in both 2019 and 2020, periods that would have warranted a more hawkish Fed stance
What to Watch
Markets will scrutinize Warsh's confirmation process closely. If confirmed, his inflation framework could reshape how the Fed communicates policy decisions and responds to price pressures. The paradox highlighted by Bhave—whereby trimmed measures might actually produce higher readings in volatile environments—could constrain Warsh's flexibility if he needs to justify a dovish stance.
Traders should monitor upcoming congressional testimony dates and any additional comments from Warsh clarifying his inflation methodology views. The interplay between trimmed-mean gauges and actual Fed policy decisions will be critical for positioning in rates markets.
During Tuesday's hearing, Warsh pushed back against suggestions that he would lower interest rates at the President's request, though critics have questioned whether he can maintain independence from the Trump administration given his nomination.