Chairman Warsh Takes the Reins. What Follows?

The Economy Kevin Warsh Inherits

The Iran war has made the economic outlook for 2026 more complicated and policy more difficult to define. For much of the remainder of the year, the country is likely to remain in an inflationary boom: growth supported by fiscal stimulus, asset-price strength, and deficit spending, but increasingly pressured by rising prices, higher interest rates, and geopolitical uncertainty.

Importantly, much of this boom was in motion before the Iran war began. The One Big Beautiful Bill, with its tax cuts and additional government spending that took effect on January 1, added momentum to an economy that was already benefiting from lower interest rates. Adding fuel to this growth is a federal government spending roughly $6 trillion while collecting about $4 trillion in revenue. That large and growing deficit is providing a powerful financial push to Wall Street, asset values, and the broader economy.

Because this is an election year, there is little likelihood of meaningful spending restraint before voters go to the polls. Fiscal policy is therefore likely to remain stimulative through the fall. In addition, part of the deficit has been financed by the Federal Reserve through a renewed form of quantitative easing. That support increases asset values, creates a wealth effect, and adds further demand to an already inflation-prone economy.

The Iran war now adds a new layer of uncertainty. Alongside the price effects of tariffs, the war and rising fuel prices have further increased inflationary pressures while also beginning to slow parts of the economy. That drag may become more visible in the second half of the year, with the most significant impact appearing after the fall elections and into 2027.

Interest Rates

The obvious question that follows this outlook is what it means for interest rates. With deficits rising, inflation proving more persistent than expected, and uncertainty growing around the supply shocks of the Iran war and related geopolitical risks, interest rates across much of the yield curve are moving higher. Paradoxically, these emerging conditions may place added pressure on the Fed to intervene and to buy securities along the yield curve to keep rates from rising. But that response carries its own risks. If investors believe the Fed is monetizing deficits or losing discipline on inflation, renewed asset purchases could stoke inflation fears and push rates even higher. I suspect the Fed will hold its policy rate steady but allow the yield curve to steepen, expecting that by doing so the inflationary impulse will be suppressed.

The New Fed Chair and Policy

Kevin Warsh, like Jerome Powell, is an experienced consensus builder. He is diplomatic, measured, and skilled at working through institutional differences. Those qualities will be essential as he works with the members of the Federal Open Market Committee.

Warsh’s economic philosophy, however, differs from Powell’s. Warsh is likely to be more concerned about avoiding a further expansion of quantitative easing, especially given his goal of shrinking the Fed’s balance sheet. That will not be an easy position to manage. Views on the balance sheet differ across the FOMC, and finding consensus on this issue may prove difficult.

He will also have to navigate divided views on future rate policy. Some members will be reluctant to see rates rise if the economy is slowing. Others will be more inclined to raise rates to address the growing inflation problem. Warsh’s challenge will be to lead the FOMC toward the best choice and then build consensus at a moment when markets are looking for clarity.

Fed Independence

Fed independence will become an increasingly important issue. The Administration will likely expect a more cooperative Federal Reserve, particularly if growth slows or financial conditions tighten. Warsh will therefore need to set expectations early regarding his own commitment, and the FOMC’s commitment, to price stability.

That may be his most important task. In an environment of large deficits, rising geopolitical risk, persistent inflation, and political pressure, credibility will matter as much as policy. If Warsh can preserve the Fed’s independence while guiding the committee through a divided and uncertain period, he will have a chance to maintain market confidence. If not, the inflationary boom of 2026 could give way to a more difficult economic environment in 2027.