It is highly probable that the Federal Reserve will maintain the federal funds rate at its current level (target range 3.5%–3.75%) during this week's policy meeting, while removing the forward guidance language from previous statements that hinted at future rate cuts. This will be the first policy meeting chaired by the new Chair, Kevin Warsh.

The global market is awaiting the signals from Kevin Warsh's debut, as these signals will ultimately filter through the US dollar index, Treasury yields, and global stock markets to impact the average person's balance sheet: the net asset value of your funds, gold prices, the RMB exchange rate, Hong Kong and US stock accounts, mortgage rate expectations, and even corporate financing and employment conditions could all be repriced by this "debut."

Why is he called the 'Strictest Father'?

Due to market discussions about Warsh's arguments for reducing the central bank's balance sheet, he has even been dubbed the Fed's "strictest father" by netizens. However, the reality may not be so straightforward.

A 'Strict Father' Not Necessarily a Hawk

Warsh's policy stance was laid bare in a recent interview. In simple terms, he wishes to reduce the Fed's purchases of ultra-long-term government bonds to strengthen fiscal discipline, but he also supports allowing the economy to run moderately hot, using growth to address debt issues.

Therefore, he may not be an extremely strict hawk and is considered a "practical monetarist." Specifically, Warsh has indeed criticized the status quo. While not directly endorsing the radical claim that "the US government issuing debt and the Fed buying it is a 'Ponzi scheme'," he clearly stated that the current setup is completely unsustainable.

He believes that since the pandemic, the Biden administration's large-scale fiscal spending and subsidies have caused government interest payments to soar from $300 billion pre-pandemic to nearly $1 trillion, with daily interest expenses reaching $3.1 billion. The Fed has played a role in constantly "bailing out" and paying for the government, indulging in fiscal waste.

Consequently, the core reform proposal is to shrink the balance sheet to force fiscal discipline. The specific methods are: ceasing supply of long-term Treasuries, where Warsh advocates the Fed should reduce direct purchases of US Treasuries (i.e., shrinking the $7 trillion balance sheet), especially stopping purchases of ultra-long-term bonds like 10-year and 30-year maturities; and market-based pricing, letting the market determine the required interest rates for the US government's long-term bond issuance instead of the Fed providing implicit subsidies.

This forces government frugality. By having the Fed not backstop the market, it compels the US Treasury and government to adhere to fiscal discipline, reducing public sector crowding out of the market and unnecessary fiscal waste at the source, which could fundamentally lower inflation.

However, the reason Warsh is not considered a major hawk also lies in his disinclination towards aggressive rate hikes. Discussing interest rate policy, Warsh expressed opposition to using rate hikes to combat inflation. As an advocate of low-interest-rate prosperity, he calculated that raising rates too high to control 5% inflation would cause the US government's annual interest payments to surge to $1.4-$1.5 trillion, which is absolutely unsustainable fiscally.

Instead, he hopes to dilute the deficit by growing the denominator (GDP). Specifically, he advocates maintaining low interest rates to sustain prolonged economic prosperity. Because the ratio of fiscal deficit to GDP is crucial; as long as the economic pie (denominator) grows larger through low rates, even if the debt (numerator) remains unchanged, the deficit ratio will decline. To this end, he is even willing to allow short-term economic overheating.

Overall, what Warsh truly cares about is clarifying the functional boundaries between the Fed and the Treasury. He believes the lines have been blurred in the past, politicizing the Fed. He advocates emulating the post-World War II 1951 agreement between the Fed and the Treasury (the famous Fed-Treasury Accord), making the Treasury responsible for the fiscal account while the Fed focuses on controlling inflation and maintaining employment, stripping away the third major duty of "bailing out the government," with each performing its own function.

Debut Unlikely to Bring Major Systemic Changes

Warsh's debut is still highly anticipated. Outside observers are keenly focused on three potential reform areas he might advance after taking office: communication style, balance sheet policy, and financial regulation.

Regarding communication, Warsh has called for "less talk," leading to market speculation he might cancel the regular release of the Summary of Economic Projections (SEP). However, most investment banks expect no major changes soon, as the FOMC's framework review last year extensively discussed this without reaching consensus.

On the balance sheet, regulatory changes could affect bank reserve requirements, but institutions do not anticipate significant quantitative tightening. For financial regulation, Warsh leans towards "light-touch" regulation for small and medium-sized banks. Regulatory Vice Chair Bowman has already advanced related early measures, gaining Warsh's approval.

This week's press conference will provide clearer insight into Warsh's priority agenda and current thinking. Stuart Rumble, Head of Investment Directors for Asia Pacific at Fidelity International, commented, "Warsh opposes forward guidance, frequent market commentary, and press conferences, planning to return to the pre-financial crisis communication model. This could raise the risk premium on long-term US Treasuries, leading to higher long-end yields and impacting bond and equity market stability."

Wall Street Does Not Expect Rate Hikes

For now, although media and speculators have begun hyping the possibility of rate hikes, Wall Street does not seem to support that view. For instance, Stuart Rumble believes Warsh tends to reference lower inflation metrics, viewing inflationary pressures as less severe than reflected by core PCE data, indicating a dovish stance favoring maintaining a loose environment. However, other Fed members hold differing views, and internal divisions could constrain policy implementation. Fidelity expects rates to remain unchanged this year.

Jan Hatzius, Chief US Economist at Goldman Sachs, reiterated in a recent research note that they do not expect the Fed to hike rates, citing two reasons: historically, the Fed has not hiked rates in response to oil shocks (unlike the ECB, etc.), and the current labor market is relatively balanced with moderate wage growth, making it less likely to trigger self-reinforcing persistent high inflation.

Nevertheless, Goldman Sachs also noted several warning signals have emerged: stronger-than-expected PPI data, a significant rise in the "prices received" component in manufacturing surveys, and a spike in the University of Michigan's long-term inflation expectations in May (which has since retreated). If inflation expectations rise markedly or high inflation spreads more widely across categories, the probability of rate hikes would increase.

More views suggest that if the Middle East conflict subsides and oil prices continue to fall, concerns about rate hikes are not significant. This round of inflation transmission resembles the typical pattern of past oil shocks rather than the widespread supply shortages and price spirals seen during the pandemic. The most severe monthly inflationary impacts from oil prices and AI-driven memory chip price increases may have already peaked, with monthly inflation rates expected to gradually decline in the second half of the year.

Significant Impact on Dollar, Gold, and Stocks

The new Chair's words and actions will dictate the logic for major asset allocation. Regarding the US dollar, Jerry Chen, Senior Analyst at GAIN Capital, noted that markets had already begun pricing in rate hikes, but the recent rally in the US dollar index has encountered technical pullback pressure near the 100 level. If the central bank refrains from hawkish rhetoric this week, it could lead to a continued pullback in the dollar index. With developments in the Middle East situation, rate hike expectations have already shrunk significantly.

Current global stock markets are dominated by technology and AI, and tech stocks are particularly sensitive to interest rate changes as this directly determines their financing costs. If rate hike expectations ease, tech stocks will undoubtedly regain momentum. Currently, mainstream institutions generally believe the S&P 500 index will break through the 8000-point mark by year-end, and the trend of US stocks will also directly impact the broader Asia-Pacific market.

Nikhil Mehra, Head of Multi-Asset Strategies & Solutions for Asia Pacific at BlackRock, recently noted that behind current high US stock valuations lies solid profit support, with overall profit growth in the tech sector around 50% to 60%; even excluding some tech stocks, overall US stock profit growth remains in the double-digit range.

Influenced by easing Middle East tensions and a weaker US dollar, gold surged over 2% on Monday morning, returning above $4300. If this trend holds, gold bulls may regain confidence.

Jerry Chen also mentioned that in the current environment, short-term overbought conditions are unlikely to affect the rebound trend in gold prices. The initial target for bulls is the $4350 area, where some resistance is expected before a breakthrough, after which it would challenge the $4480 level. In the short term, as long as it does not fall below $4245, a strategy of buying on dips can be maintained.

Looking ahead, beyond Warsh himself, the market may focus more on the US midterm elections. In Stuart Rumble's view, the political situation will form a significant constraint. If the ruling party performs poorly in the elections, Fed independence could strengthen, increasing the probability of rate hikes; if the election results are favorable, demands for policy easing could intensify, potentially weakening the Fed's policy independence.