Fed independence fears unsettle central banks as Warsh steps in

“Federal Reserve Chair Kevin Warsh’s suggestion that independence may not extend fully to the Fed’s crisis-fighting role abroad has unsettled central banking peers, who fear any reduction ‌in its global footprint could risk market stability. With the dollar by far the world’s most used currency, the US central ​bank plays a pivotal role in stabilising financial markets ‌during periods of stress. It has expanded its crisis-fighting tools over time to keep funding flowing. But Warsh, who was sworn in as Federal Reserve Chair on Friday raised eyebrows by suggesting that ‌outside monetary policy, including in international finance, the Fed needs to ‌work closely with the presidential administration and Congress. Warsh told his confirmation hearing that independence in setting interest rates did not fully extend to the Fed’s broader operations, prompting some to question whether it would remain fast and decisive when the next crisis hits. On- and off-the-record comments from more than half a dozen policymakers indicate they are attentive to Warsh’s remarks and await clarification. But they anticipate no big policy change for now, if only because Fed liquidity facilities ultimately protect the US economy as much as those of global partners. A less reliable Fed would encourage countries to keep moving away from the dollar, extending and probably accelerating a 15-year ​fall in the greenback’s global market share, they said. There is little central banks can do in the short term if the Fed curbs access to dollars, however, and even the suggestion that liquidity lines may not be readily available could generate market turbulence. “It’s a double-edged sword,” said one European Central Bank policymaker, who ‌declined to be named. “The world relies on the dollar and if the dollar is ​not readily available, everybody pays a price - the US included.” The Fed currently provides dollars on demand to the ECB ​and the central banks of Canada, Japan, Britain and Switzerland, against collateral, via standing liquidity tools. Other central banks can also access dollars through a more onerous facility. The justification for that backstop is that commercial banks overseas sit on trillions of dollars worth of US Treasury bonds, and that market stress could force them to sell quickly to access cash, importing turbulence to the United States. Inserting politics into the provision of dollars would not be new. The Trump administration gave Argentina a $20bn liquidity line ahead of elections last year, and Gulf and Asian nations recently requested liquidity lines to help deal with energy shocks and the fallout from the Iran war. Korean President Lee Jae Myung reportedly raised the issue during a meeting with US Treasury Secretary Scott Bessent this month. Nomura Research Institute economist Takahide Kiuchi, a former BOJ board member, noted the impact Fed policies can have on other markets. “Warsh could attempt a tightrope of conducting dovish interest rate policy that aligns ‌with Trump’s hopes, while guiding a hawkish balance sheet policy,” ‌Kiuchi said. “Any rupture in the US market caused by such Fed moves, coupled with rising oil prices from the Iran war, could further push up 10-year Japanese Government Bond yields. That, in turn, could hurt Japan’s economy and stock prices.” Another source argued that it was in the Fed’s interest to keep dollars flowing from abroad to help finance the high US budget deficit. A less reliable Fed could ultimately channel market demand towards the euro, the world’s second most-traded currency. The ECB has made efforts to increase its market share and widen euro availability. But the single currency’s architecture is not yet adequate to take on a significantly greater role and vast internal reforms are still needed, a third source said.

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