Thoughts

January 30, 2026 | 15:02

Washington’s Wild Week: Warsh and Warding Off a Shutdown

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

The final week of January is ending just as it began in Washington: like a lion. Two events, in particular, came to the fore on Friday: The President nominated Kevin Warsh to become the new Fed Chair in May, and Congress scrambled to avert another federal government shutdown. Warsh’s nomination still needs to be approved by the Senate Banking Committee. Despite a few lawmakers claiming they won’t approve any nominations until the White House’s legal proceedings against the Fed, Chair Powell, and Governor Cook are resolved, there’s a reasonable chance Warsh will get the nod given his experience as a Fed Governor (2006-2011) and general Republican support.

Warsh was chosen despite his past hawkish credentials, earned during the financial crisis when he favoured tighter policies than were put in place. In 2008, at the depths of the crisis, he said that extra rate cuts could ignite inflation. He also pushed back against quantitative easing in 2011, when the FOMC opted to buy Treasury bonds to further reduce long-term rates. As the new Chair, Warsh will likely promote shrinking the Fed’s balance sheet by either selling Treasuries or not reinvesting maturing proceeds. That could put mild upward pressure on long-term rates, and, in fact, 10-year Treasury yields inched up on the announcement.

Shorter-term rates, however, fell slightly (steepening the yield curve) as fed funds futures priced in somewhat higher odds of at least two rate cuts this year. Indeed, any moves toward shrinking the balance sheet could warrant additional rate cuts. More recently, Warsh has been a consistent proponent of lower rates, for two reasons. First, he believes artificial intelligence will be a “significant disinflationary force” by boosting productivity. Second, he thinks that excessive government spending and money printing are the root causes of inflation. Unless inflation sparks, he is likely to try to run the economy hot. This more reactive than preemptive approach could fan inflation, but it may also prove prescient if productivity growth strengthens and contains price pressures.

Of course, the new Chair would still need to coax six other members of the 12-member FOMC to vote likewise, but that may not be a major issue given his prior experience at the Fed and the view that current policy rates are still near the upper end of a neutral range. This assumes inflation makes some further progress toward the target and job growth remains soft for much of the year.

The upshot is that Warsh is almost certain to push for lower policy rates, at least in the near term. His nomination supports our outlook for three more rate cuts this year, taking policy to a mildly stimulative setting. Pushing for even more rate cuts, as the President recommends, could run into resistance if the economy continues to outperform and inflation remains sticky. That’s when the issue of Fed independence will be put to the test. But Warsh’s record suggests he may be up to the test, and that upside inflation surprises would not be tolerated.

Turning to the prospect of a second federal government shutdown in less than three months, the good news is that the odds of a deal appear high; and even if there is a partial closure, the economic sting will be much less than in the fall.

Half of the twelve annual appropriations bills have already been signed into law by the President. They cover funding for Justice, Commerce (including the Census Bureau), and several other departments. This implies less disruption than the closure late last year. Moreover, the House has already approved the remaining six bills that would fully fund the government through September. However, sixty votes are required to advance these bills in the Senate, meaning that Republicans (who have a 53-47 seat majority) will need some Democrat support. The latest news suggests the White House and Senate Democrats have agreed on a deal for five of the bills, all except immigration. If passed in the Senate, the House would need to approve the changes, which might be delayed a few days.

Absent passage of the six funding bills, a continuing resolution would need to be approved to temporarily cover funding for some departments, including the Bureau of Labor Statistics. If this fails, we could see delays in the employment and CPI reports. But continued funding for the Commerce Department will keep scheduled releases for real GDP, retail sales, personal spending, and the all-important PCE price data on track. Even without passage of the remaining bills or a continuing resolution, much of the government would stay open. While hundreds of thousands of federal employees could be furloughed or required to work without pay, a shutdown of equal duration as the last one would have a much smaller impact on the economy, likely less than half a percentage point hit to Q1 annualized growth. That could easily be offset by the continued AI boom now propelling business investment.