Warsh's push to strengthen Fed credibility earns an initial market nod, but tightening liquidity may pressure U.S. stocks in the short term

Overview

The report centers on policy communication and market reaction after Kevin Warsh took over as Federal Reserve Chair. Its core view is that Warsh's appointment helps repair market doubts about the Fed and policymakers' credibility, especially against the backdrop of the earlier surge in precious metals and market skepticism about the sustainability of a 'run it hot' policy. The report argues that the roughly 40% rise in the S&P 500/Gold ratio since the nomination is the market's vote for Warsh's potential to reshape the Fed, reduce reliance on balance-sheet policy tools, and strengthen inflation credibility. At the same time, the report stresses that the short-term path will not be smooth, and equities may be disturbed by tightening liquidity, a bear-flattening yield curve, and a stronger dollar.

Core views

First, Warsh's appointment is viewed as a stabilizing event because it may strengthen the Fed's inflation credibility and reduce dependence on the balance sheet. Second, Warsh's first meeting sent a hawkish signal: it emphasized inflation as the top priority, reduced forward guidance, and allowed market prices to become an important information source for central bank decision-making again. Third, the report does not believe Warsh will mechanically pursue a hard 2% inflation target; instead, he may tolerate an inflation range of 2%-2.9% in order to maintain higher nominal growth and ease debt pressures without losing control. Fourth, the most important near-term issue is not rate hikes themselves but weakening liquidity, including RMP reduction, lower Treasury buybacks, and credit growth absorbing funds. Fifth, on geopolitics, Iran peace talks may affect near-term price action; however, the report is bearish on oil over the long term, arguing that conflict could stimulate new supply and greater demand for energy independence.

Analysis framework

The report mainly uses a market-signal interpretation framework, treating the S&P 500/Gold ratio, yield curve, dollar, precious metals, and risk-asset prices as observables for Fed credibility and policy trustworthiness. It also combines the Fed balance sheet, the Reserve Management Program, Treasury buybacks, loan growth, and financial conditions to assess the marginal impact of liquidity on U.S. equities. The weekly charts also cover the earnings snapshot, S&P 500 EPS, sector ratings, equity risk premium, small-cap relative performance, and earnings revision breadth.

Methodology notes

• Market SignalS&P 500/Gold Ratio

  The relative performance of stocks versus gold is used as a composite signal of policy credibility, inflation-hedging preference, and risk appetite.

  The report argues that the ratio has risen nearly 40% since Warsh's nomination, indicating that the market is more willing to use equities rather than precious metals as the hedge in an inflationary environment and is giving Warsh credit for reshaping Fed credibility.

• Macro PolicyFed Reaction Function and Forward Guidance

  By observing whether the Fed emphasizes inflation and whether it reduces the dot plot and forward guidance, the report infers changes in policy communication.

  The report believes that reducing forward guidance helps market prices reflect economic data again rather than merely echoing the Fed's own communication, thereby improving the information quality of policy decisions.

• LiquidityRMP, Treasury Buybacks, and Loan Growth

  Financial-system liquidity is measured using balance-sheet support, Treasury buybacks, and credit expansion.

  The report notes that the RMP has fallen sharply from its peak, Treasury buybacks have declined, and loan growth has accelerated. Taken together, liquidity conditions are tightening and may weigh on equities before July.

• Earnings TrackingUS Earnings Snapshot

  Earnings trends are monitored by combining economic activity, business confidence, supplier delivery, wage tracking, inflation issues, and monthly GDP cycle factors.

  The chart shows that earnings inputs include Philadelphia Fed economic activity, Creighton University business confidence, Chicago Fed supplier delivery, Atlanta Fed wage tracking, NFIB small-business inflation issues, and the Brave-Butters-Kelley monthly GDP cycle component.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• U.S. equities/S&P 500

  Core research focus

  Strengths

  The S&P 500/Gold ratio has risen sharply, showing that stocks are more favored by the market than gold; the earnings chart still shows double-digit EPS growth expectations for several quarters.

  Weaknesses

  Near-term headwinds include tightening liquidity, bear flattening of the yield curve, a stronger dollar, and hawkish policy communication.

  Comparison

  The report argues that stocks have been a better inflation hedge than precious metals.

  Risks

  If the market tests the Fed's new credibility, financial conditions tighten further, or earnings estimates are revised down, U.S. equities could pull back in the short term.

• Gold and precious metals

  Inverse indicator of policy credibility and inflation concerns

  Strengths

  The earlier rally in precious metals reflected market concerns about inflation and policy credibility and can still serve as a credibility-stress indicator.

  Weaknesses

  After Warsh's nomination, the S&P 500/Gold ratio rose about 40%, and precious metals weakened after the first FOMC, showing that they are in a short-term disadvantage versus stocks.

  Comparison

  Relative to the S&P 500, performance has lagged, which the report views as confirmation that the market believes Fed credibility is being repaired.

  Risks

  If inflation gets out of control, the dollar weakens, or the bond market again questions policy credibility, precious metals could strengthen again.

• U.S. rates and yield curve

  Policy reaction and financial-conditions transmission channel

  Strengths

  The bear flattening of the yield curve reflects the market's view that the Fed is placing greater emphasis on inflation credibility.

  Weaknesses

  The faster rise in 2-year yields may weigh on equity valuations and risk appetite.

  Comparison

  Compared with stocks and precious metals, the rates market more directly prices hawkish communication.

  Risks

  If long-end rates and volatility get out of control, the sustainability of the 'run it hot' strategy will weaken.

• U.S. dollar

  An asset that benefits from Fed credibility and a hard anti-inflation stance

  Strengths

  The dollar strengthened after the first meeting, consistent with the market's reaction to a harder monetary stance.

  Weaknesses

  An overly strong dollar could weigh on multinational corporate earnings and global risk assets.

  Comparison

  Relative to precious metals and bitcoin, the dollar was stronger in the near-term market reaction.

  Risks

  If policy credibility cannot be sustained or fiscal/debt issues again take center stage, dollar strength could reverse.

• Crude oil

  An asset tied to geopolitics and supply adjustment

  Strengths

  Iran-related negotiations may affect oil prices and market risk appetite in the near term.

  Weaknesses

  The report is structurally bearish on oil, arguing that conflict may spur demand for energy independence and new supply.

  Comparison

  Like precious metals, oil is sensitive to geopolitical risk in the near term, but the report is more negative on oil over the medium to long term.

  Risks

  If the conflict escalates and causes actual supply disruptions, oil prices could stage a temporary rally.

• RELIANCE INC / RS.US

  A stock identified in the entity extraction, but no explicit investment thesis is formed in the body

  Strengths

  The source data identifies it as a steel-sector company.

  Weaknesses

  The report is a U.S. equity strategy note, not a RELIANCE INC company report, and it provides no rating, target price, or core view on the stock.

  Comparison

  This strategy weekly should not be interpreted as a stock-specific recommendation on RS.US.

  Risks

  The entity extraction may come from table or disclosure noise; investment use should be verified against the original text.

Key data

• S&P 500/Gold ratioNearly up 40% since Warsh's nominationThe report sees this as a positive market signal that Warsh will reinforce Fed credibility and reduce dependence on the balance sheet.
• RMP size changeDown about 75% from the peak; from roughly $40B per month to roughly $10BThe report views the weakening of balance-sheet support as an important source of near-term liquidity risk for U.S. equities.
• Treasury buybacksDown about 50%Back-end purchases were roughly flat, but overall buyback support weakened, reducing liquidity support for financial markets.
• Initial market reactionStocks and bonds weakened, the yield curve bear-flattened, the dollar strengthened, and precious metals and bitcoin weakenedThe report interprets this as the market reading Warsh's communication as incrementally hawkish and supportive of a stronger price-stability credibility.
• S&P 500 earnings expectationsThe chart shows double-digit EPS growth expectations for several 2026 quartersThe disclosed chart includes earnings growth expectations for Q2 2026E, Q3 2026E, Q4 2026E, and other periods, but the OCR and image information are partially truncated.
• Sector recommendationsOverweight Consumer Discretionary, Financials, and Industrials; Underweight Staples and Real EstateFrom Morgan Stanley's Sector Recommendations table.

Impact & implications

For portfolios, the implication is that the volatility cost of repairing policy credibility should not be ignored in the short term: if the Fed provides less forward guidance and relies more on data and market prices, risk assets may face higher rate volatility and less policy support. The strength of equities relative to gold supports the medium-term view that U.S. stocks should outperform precious metals, but tightening marginal liquidity could leave equities under pressure before July. A stronger dollar and rising real rates are negative for gold, silver, and bitcoin; meanwhile, if the economy remains strong and nominal growth stays high, some cyclical and financial-related sectors may benefit more.

Risks

• Liquidity conditions may continue to tighten, with RMP reduction, lower Treasury buybacks, and loan growth absorbing funds together weighing on equities.
• The market may test the Fed's new policy credibility under Warsh, leading to higher volatility in rates, the dollar, and risk assets.
• If inflation remains above target and the Fed has to respond more forcefully, valuations and risk appetite may come under pressure.
• If the yield curve continues to bear-flatten, financial conditions may tighten further and hurt small caps and high-valuation sectors.
• Iran-related peace talks or conflict developments could trigger short-term volatility in oil, the dollar, and risk assets.
• The report includes multiple disclosures and potential conflicts of interest; Morgan Stanley has investment-banking or other service relationships with some covered companies.

What to watch

• Whether Warsh continues to reduce forward guidance and whether markets can price assets stably without a dot plot.
• Whether the Fed truly reduces the use of the balance sheet as a policy tool and the conclusions of the relevant task force.
• Marginal changes in RMP size, Treasury buybacks, and loan growth, especially liquidity conditions into July.
• Whether the S&P 500/Gold ratio can remain strong or whether precious metals will again reflect inflation and policy-credibility concerns.
• The direction of the 2-year and 10-year Treasury yields, the shape of the yield curve, and rate volatility.
• The co-movement of the dollar, gold, silver, bitcoin, and stocks to judge whether the market continues to accept the 'hard money + high nominal growth' combination.
• S&P 500 earnings revision breadth, small-cap relative performance, and sector rotation.