Kevin Warsh, the Fed and uncertainty on the US labour market - February 2, 2026
The choice of Kevin Warsh to succeed Jerome Powell as head of the Fed raises many questions, but in the short term, the main and thorny issue facing the Fed and investors remains unchanged: that of the US labour market. Will it remain surprisingly weak or, on the contrary, follow the ongoing acceleration in GDP growth with a slight delay?
Donald Trump has therefore decided to propose Kevin Warsh's nomination to Congress to replace Jerome Powell as head of the Fed in May. A member of the Fed from 2006 to 2011, he was opposed to Ben Bernanke's quantitative easing policy at the time. Kevin Warsh now seems to be arguing both for a cut in interest rates – he does not believe there is a risk of inflation – and for a reduction in the size of the Federal Reserve's balance sheet, for reasons that are less clear. The Fed's balance sheet has already fallen significantly since 2022, but at 20% of GDP, it remains well above the 6% level seen before 2008 (Chart 1).
The Fed is operating the money market differently than it did before 2008, which requires a larger balance sheet. This led it to end the process of reducing its balance sheet last December. Kevin Warsh undoubtedly wants to return to the old system in order to reduce the Fed's footprint. We will see whether he manages to convince his colleagues of the merits of this project when he takes office. In the short term, however, US monetary policy will remain largely dictated by the behaviour of the labour market.
At his press conference on 28 January, Jerome Powell expressed a degree of economic optimism, which prompted the Federal Reserve to pause after three consecutive rate cuts. The rebound in consumption, up 3.5% in Q3 and likely to reach 3% in Q4, is encouraging. The prospect of a positive fiscal stimulus at the beginning of 2026 also points to strong GDP growth in 2026 – the Bloomberg consensus is for growth of over 2% throughout the year. Does this optimism mean that the Fed will not cut rates further in 2026? Nothing is less certain, as the sharp slowdown in the labour market contrasts with more favourable GDP statistics (Chart 2).
Jerome Powell suggests that certain statistics, such as the small decline in the unemployment rate in December 2025, from 4.5% to 4.4%, could herald a stabilisation. But he clearly explains that the Fed remains alert on this key point of its mandate, which explicitly stipulates maximising employment, not GDP. Concern is palpable among American households, who find it increasingly difficult to find or return to work (Chart 3).
How can we explain this divergence between reassuring GDP statistics and more worrying employment statistics? An initial reaction would be to consider, in a fairly conventional manner, that the employment cycle is simply lagging behind the business cycle. The current weakness in employment would be a temporary consequence of the economic slowdown in the first half of 2025 and the climate of uncertainty created by the trade war.
Another possibility is that GDP figures may be overestimating economic momentum. This is suggested, for example, by the sluggish business climate described by business leaders in surveys (ISM, PMI, etc.), or by weak consumer confidence (Chart 4). In the same vein, the idea of a US ‘K-shaped economy’ boosted solely by certain sectors (AI) and certain categories (the wealthiest) is gaining popularity, even though this theory fails to explain the resilience of household consumption.
Third interpretation: labour productivity. Statistics show that it has been accelerating again in recent years, reaching nearly 2%, double the average for the 2010s (Chart 5). If this is confirmed in 2026 – whether due to AI or other factors – the Fed may be led to aim for stronger economic growth in order to generate decent job growth. This appears to be the opinion of Kevin Warsh, who believes in the scenario of an AI-driven productivity boom.
Whatever Kevin Warsh's intentions, these issues will be unavoidable for monetary policy. As Jerome Powell points out, if the labour market remains weak and/or inflation returns to around 2% once the effect of tariffs has passed, the Fed will resume its path of rate cuts – the markets are expecting two this year, for a total of 50 basis points. If, on the other hand, growth accelerates and employment follows suit, the likelihood of further monetary easing will fall sharply, disappointing investors' expectations. Ten-year bonds are currently yielding 4.25%, just 60 basis points more than short-term rates (Chart 6). This scenario, the probability of which we find difficult to assess at present, is one of the reasons why the bond duration of our Global Macro portfolios remains fairly moderate.
