President Trump officially nominated Kevin Warsh to be the next Federal Reserve Chair after a lengthy, highly publicized search. The Treasury market reacted unevenly, with short-term yields dropping while longer-term yields remained high. Markets aren’t fully pricing in a rate cut until late July, showing skepticism about how quickly Warsh can influence policy. Although Warsh was previously hawkish as a Fed governor, his recent comments seem more dovish, aligning with the administration’s preference for rate cuts. Still, his true policy leanings and how long they will last remain open questions.
Warsh’s ability to influence monetary policy will largely depend on his skill in building consensus within the Federal Open Market Committee. While the chair generally holds influence, committee members do not automatically defer; past chairs have positioned themselves near the FOMC’s center to avoid being outvoted. Warsh may strongly advocate for rate cuts and a smaller Fed balance sheet, but convincing a diverse committee — especially amid concerns about the Fed’s independence — will be challenging. Some policymakers might be open to reducing the balance sheet, though traditional theory suggests this could push long-term rates higher, potentially conflicting with goals such as lowering mortgage costs.
The confirmation process is likely to take longer. Republican Sen. Thom Tillis of North Carolina has supported Warsh but has refused to proceed with confirmations due to ongoing Justice Department investigations into Fed officials, delaying his approval. Powell’s future as chair remains uncertain, and the administration may face pressure to resolve investigations to move forward with confirmation. Based on current data — particularly core inflation moving away from the target — analysts still expect the Fed to keep rates steady for the rest of the year, with any policy shifts mostly driven by economic developments and internal FOMC dynamics.
The latest FOMC meeting brought no changes or new signals on the Fed’s balance sheet, and funding markets handled January month-end smoothly, with repo rates staying well-behaved compared to recent reporting periods. The bigger message was about policy stance: the Fed is “on hold,” not merely “paused.” That distinction matters — officials now see rates as being at an appropriate level and are waiting for incoming data to justify a move in either direction, rather than expecting a continued sequence of cuts.
While two policymakers dissented in favor of easing and some members still anticipate rate cuts eventually, Powell emphasized that cuts are less urgent now that rates are within the broad range of “neutral.” At the same time, he did not rule out a hike if conditions warranted, stressing flexibility. Although a handful of participants believe rates are already near neutral, most still view policy as somewhat restrictive — but close enough to neutral to reduce the pressure for immediate action.
Powell argued that the recent dip in the unemployment rate signals stability, especially when paired with strong GDP growth, which he believes should support labor demand over time. The counterargument is that growth may be coming from higher productivity — firms getting more output from existing workers through technology — rather than from increased hiring. If that’s the case, strong GDP doesn’t necessarily translate into stronger employment. Historically, as in the 1990s, the Fed faced a similar debate about whether productivity gains allowed faster growth without inflation, but recognizing that in real time required a policy leap of faith.
Several labor market indicators suggest conditions are weaker than the Fed’s interpretation implies. Wage growth — a key signal of labor demand — continues to cool, with measures like the Atlanta Fed wage tracker falling to post-pandemic lows. Long-term unemployment has risen, payroll growth has been extremely soft, and unit labor costs are slowing. These trends point more toward weak labor demand than a worker shortage. Dissenting Fed officials argue this resembles a stagnating job market masked by headline GDP strength, warning that without rate cuts, employment could deteriorate further.
TreasuryMarket
The Treasury market absorbed Kevin Warsh’s appointment very well. The one-year part of the curve went lower, and the long end steepened marginally. The 2/10 spread moved 7 basis points higher than last week.
Municipal Market
Municipal yields continued to drop, reflecting increased demand and continuation of the January reinvestment effect. The 2/10 slope remain unchanged at 41basis points. (The long-term average is 1.49%.)
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
Treasury-muni ratios widened in the shorter maturity and tightened in the longer maturities.
Investment Grade Corporates
Investment-grade corporate bond yields reflected the Treasury curve where the short end was lower while the intermediate and long end steepened.
Risk sentiment remains elevated due to ongoing policy deadlocks and geopolitical tensions. Lawmakers continue negotiations over government funding, having passed several appropriations bills while others await Senate approval. Key sticking points include immigration policy and Department of Homeland Security (DHS) funding. Despite half of the annual funding bills passing, the remaining ones are stalled in the Senate primarily over disagreements concerning DHS resources and immigration enforcement.
Recent tragic events in Minneapolis have increased scrutiny of federal immigration operations, prompting Senate Democrats to seek to separate DHS funding from the broader package and to demand operational reforms such as warrants for home entries, body cameras, limits on enforcement sweeps, and clearer agent identification. Some Republicans are also open to investigations or hearings, leading to rare bipartisan cooperation on enforcement oversight.
The funding deadline passed, and a partial government shutdown continues, with the House set to return on Monday. This is raising concerns about the impacts on federal services, such as IRS operations, amid tax season. Disruptions threaten refund processing and audit capacity, even as Republicans push for larger refunds aligned with recent tax legislation.
Meanwhile, Congress is adopting a tougher bipartisan stance on China, especially regarding the export of advanced technology. Proposals like the GAIN AI Act and the AI OVERWATCH Act aim to enhance congressional oversight on the sale of high-end AI chips to adversaries, reflecting growing skepticism of the administration’s more flexible export controls. This tension highlights a broader strategic divide about how aggressively to pursue tech decoupling, especially considering China’s influence over critical minerals.
The 5-year Breakeven Inflation Rate finished the week of Jan. 26 at 2.53%, 7 basis points higher than last week. The 10-year Breakeven Inflation Rate finished the period at 2.36%, 4 basis points lower than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds remained unchanged at 1.01%. The historical average credit spread is at 1.68%.
Investment-grade spreads are tight at 96 basis points this week. The long-term average is 1.56%.
Money Market Flows (millions of dollars)
Money market fund flows were largely higher week-over-week, except for tax exempt.
Mutual Fund Flows (millions of dollars)
Mutual fund flows in total were higher week over week.
ETF Fund Flows (millions of dollars)
Net ETF flows were down week over week.
Municipals are in a strong position as February begins, expected to see record reinvestment capital, following a near-record January for tax-exempt supply driven by high inflows and supportive reinvestment. This week boasts a good calendar with supply at approximately $8 billion and $40 billion coming up in reinvestment capital.
The Fed is “on hold,” meaning rates are at a level it considers appropriate until data indicate a move is warranted, rather than simply pausing ongoing rate cuts. The FOMC’s risk assessment shifted from “elevated employment risks” to “balanced risks,” reducing the rationale for immediate rate cuts. Powell emphasized that employment stability is supported by strong GDP growth, but much of that growth may be driven by productivity gains rather than new hiring. We anticipate a protracted confirmation process for Kevin Warsh as the new Fed Chair.
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