The most impactful news last week was the swearing in of Kevin Warsh as the new Chair of the Federal Reserve.
An entire generation of market traders – between the 2000 dot-com crash and today – has learned to bet heavily on a “Fed put,” and activist Federal Reserve that will pump monetary stimulus whenever the stock market drops or the economy falters. From Alan Greenspan to Ben Bernanke to Jerome Powell, the Fed has been acting like the driver of a vehicle on a winding road. They adjust their policies month by month to fulfill their dual legal mandate of maintaining price stability and full employment while acting as the lender of last resort during a crisis.
But even more, the Fed has intervened heavily in the bond market by buying long-term Treasury and mortgage bonds and lending money with less than pristine collateral on a gigantic scale (Quantitative Easing or QE). Although the Fed has gradually shed the Covid buildup (Quantitative Tightening) they still have the giant book of bonds they started in the 2008 Great Financial Crisis (GFC). In 2026, they began QE again with the excuse that the banking system needs the liquidity.
The Fed’s suppression of interest rates started by Greenspan in 2001 led to a tremendous amount of malinvestment, from NINJA mortgages leading to the GFC to private equity’s destructive takeover of many American companies to absurdities like SPACs.
(Some say the post-Covid inflation was due to the Fed but actually relatively little went into consumer pockets. It was the fiscal stimulus from Congress that went directly to consumers, sparking the explosion of demand and therefore consumer price inflation (along with supply chain interruptions that reduced supply).)
Since Alan Greenspan, the Fed Chairs have followed with this micromanagement of the economy via monetary manipulation. (cf. “21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19,” by Ben Bernanke).
Market traders swim in this Fed micromanagement regime the way that fish swim in water. For the past 25 years, the Fed has been dedicated to maintaining economic stability and is up to their elbows in monetary manipulation. Market traders know no other way by now.
Kevin Warsh is philosophically opposed to the Fed’s manipulation. He was a Fed governor during the GFC but quit in 2009 in protest of QE2. Warsh gave a speech in 2009 expressing his philosophy that Fed manipulation of the market was “deviancy.” (An expression taken from New York Senator Daniel Patrick Moynihan who deplored the unraveling of society as “defining deviancy downward.”)
Speech
June 16, 2009
Defining Deviancy
Governor Kevin Warsh
At the Institute of International Bankers Annual Meeting, New York, New York
In a seminal essay delivered about 16 years ago, Senator Daniel Patrick Moynihan offered a striking view of the degradation of standards in society.1 He observed that deviancy–measured as increases in crime, broken homes, and mental illness–reached levels unimagined by earlier generations. As a means of coping with the onslaught, society often sought to define the problem away. The definition of customary behavior was expanded. Actions once considered deviant from acceptable standards became, almost immaculately, within bounds…
Given the financial crisis, deep contraction in the real economy, and extraordinary fiscal and monetary responses, I cannot help but wonder what constitutes deviance in economic terms in 2009 and beyond. What level of real economic output and unemployment is expected and, more important, accepted? And what level of volatility constitutes the “new normal”?4 As I will discuss, we must be wary of macroeconomic policies that–in the name of stability-- may have the effect of lowering trend growth and employment rates.
In Moynihan’s framework, will we in the official sector be accepting of periods of significant financial and economic distress, however infrequent? That is, will deviancy be defined down with the understanding that a rare crisis is the price for dynamic, robust economic growth? Or will the official sector say, “Never again–not on our watch,” and become less tolerant of deviations in economic and financial conditions? Under the mantle of reforming capitalism, will policymakers instead define deviancy up, and seek to guarantee stability in our economic affairs?
I suspect that, for a time, policymakers will be more attracted to this latter path. Stability is a fine goal, but it is not a final one. Long after panic conditions have ended, stability threatens to displace economic growth as the primary macroeconomic policy objective. But we must recognize that the singular pursuit of stability, however well intentioned, may end up making our economy less productive, less adaptive, and less self-correcting–and in so doing, less able to deliver on its alluring promise. This fate, however, does not have to be ours. The U.S. economy is capable, in my judgment, of delivering more. …
The level of support that the financial system is capable of providing also remains highly uncertain. Private financial institutions are now understandably slow to create new products that connect savers and investors. Although it is undesirable to revert to the excessive risk-taking that preceded the crisis, current financial practices seem suboptimal in promoting economic growth. Furthermore, repeated interventions by the public sector run the risk of causing systemically significant institutions to operate more like public utilities than efficient allocators of capital and proper arbiters of liquidity… [end quote]
Warsh’s focus is on productivity in the real economy. He believes that the free market encourages productivity growth and that the Fed’s actions to tamp down economic swings interfere with the efficiency of price discovery which helps power real productivity growth.
This is a true philosophical about-face. The trend change won’t be immediate because Warsh is only one vote on the 12-member FOMC. But he does truly believe that the Fed should intervene much less in the economy. He plans to allow the huge Fed assets to taper off by allowing bonds to mature and not roll them over.
Practical takeaways:
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A move to QT by shedding the Fed’s huge book of bonds will increase long-term interest rates. This will depress the value of all bonds, even TIPS which are adjusted for inflation. This is already beginning.
https://fred.stlouisfed.org/series/DFII10 -
Mortgage rates, which had been gradually declining, turned upward.
https://fred.stlouisfed.org/series/MORTGAGE30US -
This is leading to a “bear steepening” of the Treasury yield curve as long-term yields rise faster than the fed funds rate. (In the chart below, slide the vertical red line in the right-hand chart to see the movement of the yield curve.) A bear steepening leads to loss of value of the trillions of dollars of existing bonds that underpin banks, insurance companies, pension funds and individual investors all over the world.
Dynamic Yield Curve | StockCharts.com
President Trump appointed Warsh largely because Warsh agreed to reduce the fed funds rate with the rationale of increased productivity. But this is a false rationale. The fed funds rate is an overnight rate. The capital investments that lead to increased productivity take years to build and the cost is financed by long-term debt, not overnight debt.
Monetary policy predicts that a lower fed funds rate will increase inflation. When Fed Chair Burns lowered the fed funds rate under pressure from President Nixon during the 1974-5 recession caused by the Arab oil embargo, inflation roared out of control.
Fed Chair Jerome Powell endured intense pressure, insults and even a spurious lawsuit from President Trump to hang tight on Fed independence and resist lowering the fed funds rate.
Inflation is high and the economy is growing strongly above trend. If Warsh pressures the FOMC to cut the fed funds rate he will lose credibility. The options market is betting that won’t happen. Options traders are predicting a 2/3 probability of a fed funds raise by December.
Latest Atlanta Fed Real GDPNow Estimate for 2026:Q2, Updated: May 21, 2026 is 4.3%. This is above trend and much higher than the “blue chip economists” estimate.
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
The stock indexes are off to the races. The SPX Price/ earnings ratio, based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), is 42, just a hair lower than the dot-com maximum of 44 and way over the 1929 peak.
The Fear & Greed index is in Greed. The trade is risk-on.
The Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems, shows that conditions have stabilized at a loose level.
Margin debt rose for the first time in three months to a record high in April, coming in at $1.30 trillion. This marked a 6.8% increase from March and a 53.3% rise compared to the previous year.
We are currently sitting at an historic extreme, meaning the gap between what people own and what they owe has never been this wide.
Data Center Drama – May 22, 2026
by David Bahnsen, The Dividend Cafe
…
Total technology investment was the major driver of economic growth in 2025. Harvard economist Jason Furman, a straight shooter even when he is wrong, calculated that investment in technology accounted for 92% of GDP growth last year. Renaissance Macro Research estimates that AI data center buildouts represented a higher dollar contribution to GDP growth than all consumer spending did last year…
What we do know is that total construction spending declined 1.4% last year, but data center construction spending increased 30% on the year, leaving mathematically inclined people to calculate how brutal the drop in construction spending would have been had it not been for data center construction. The data center sub-category was 4x higher in 2025 than it was in 2021, and this represents actual spending – not merely planned or desired projects awaiting entitlement. The backlog and pipeline will see that number increase another 10x in the years ahead. We are spending more on data centers than all other manufacturing facility categories put together.
Our Industrial Production for IT equipment is up 80% since the decade began, but for everything else it is … dead flat. S&P Global’s study concluded that 80% of our GDP growth in 2025 is attributable to data center and data center adjacent (tech equipment) spending. …
The entire point is that these investments put assets into place that drive sustained growth via greater productivity. In other words, either these data centers lead to greater productivity via the entire adoption and implementation of AI, or they fail to do so, in which case the whole AI thesis is strained. But the point is that the stakes are very high for GDP growth here: either data center construction is vital to the present and future of U.S. economic growth, or we are about to strand a lot of wasteful assets in never-never land… [end quote]
The tech giants are reporting record profits and powering the SPX and NAZ higher. But their hundreds of billions of sales are to each other. Only a small fraction of sales is to actual end-users of the AI service.
The model of power- and water-sucking data centers that burden locals with costs while funneling any profits to the few owners is causing massive blow-back leading to localities banning data centers. NIMBY on steroids with good reason. Far more than the data build-out in 1999 ever did.
We can be sure that Kevin Warsh will not use the Fed’s facilities to rescue lenders or shareholders when companies are bankrupted. That’s against his philosophy of market discovery.
The METAR for next week is sunny.
But I have moved to an even more defensive posture than usual since the bubble has inflated way past reason and bond yields are rising.
Wendy
https://en.macromicro.me/charts/415/us-margin-debt
https://www.advisorperspectives.com/dshort/updates/2026/05/20/margin-debt-up-6-8-in-april-to-a-record-high