This bull market isn’t going to end because of Fed rate hikes under Warsh
Markets love simple stories, and the cleanest one in finance is that the Federal Reserve hikes rates, liquidity dries up, and the bull market dies. If Kevin Warsh were steering monetary policy and raising rates with a more hawkish bent, many would rush to that conclusion. They shouldn’t. Bull markets almost never end simply because policy rates go up. They end when the hikes push the economy into recession, when a financial accident erupts, or when earnings roll over. None of those outcomes is mechanically guaranteed by a Warsh-style normalization path.
What actually ends bull markets
– Recession risk: Sustained equity bear markets have historically required a downturn in profits and employment. Rate hikes are the conduit, not the cause; they become dangerous only when real policy rates sit meaningfully above the economy’s neutral rate for long enough to choke credit and demand.
– Financial stress: Tightening becomes lethal when it exposes leverage and duration mismatches in fragile corners of the system. That typically shows up first in widening credit spreads, bank funding stress, or a seizing repo market—not in the fed funds target per se.
– Earnings deterioration: Valuation multiples can compress as rates rise, but bulls persist if earnings grow fast enough to offset multiple pressure. The killing blow is an earnings recession, not a basis-point count.
Why a Warsh-led hiking cycle need not be fatal
Kevin Warsh’s published views point to a preference for a more rules-based, risk-aware, and less experimental Fed. He has criticized prolonged quantitative easing, forward guidance that anesthetizes market signals, and the notion of a perpetual “Fed put.” That profile suggests a regime with clearer guardrails: allow term premia to normalize, lean against financial excess, and keep policy data-dependent rather than calendar-dependent.
Paradoxically, that approach can be friendly to a durable bull market:
– Hikes that reflect growth: Equities tend to do fine when the Fed is raising rates for the right reason—stronger nominal growth and firming productivity. In those regimes, top-line revenues rise, margins stay resilient, and earnings growth offsets some valuation compression.
– A higher neutral rate, higher capacity for rates: If the economy’s neutral real rate has drifted up—owing to demographics, investment in AI and reshoring, and persistent fiscal impulse—the cycle can absorb higher policy rates without tipping into contraction. In that world, “higher for longer” is normalization, not strangulation.
– Better capital allocation: Removing the anesthetic of ultra-cheap capital can redirect flows from the most speculative corners to productive uses. That rotation supports breadth, reduces fragility, and can extend the life of a cycle even if it raises day-to-day volatility.
Expect rotations, not ruin
Under a Warsh-style framework, the leadership inside the equity market would likely shift rather than collapse:
– From duration to cash flows: Long-duration growth franchises may see multiples compress as real yields rise, but companies with strong free cash flow, pricing power, and operating leverage can out-earn higher discount rates.
– Cyclicals and financials find a bid: A steeper curve and firmer nominal growth tend to support banks’ net interest margins, selected industrials, energy, and materials—especially if capex cycles in infrastructure, energy transition, and supply-chain reconfiguration persist.
– Quality bias matters: Balance-sheet strength, interest coverage, and return on invested capital become more important as liquidity is priced properly. That favors high-quality factors over pure momentum.
Liquidity, QT, and the plumbing
A Warsh-led Fed would likely lean more on balance sheet normalization and less on experimental tools. That does not automatically equate to a liquidity cliff:
– Ample buffers exist: Standing repo facilities, large reserves relative to pre-2020 norms, and a deep Treasury market intermediary network reduce the odds that QT sparks a disorderly funding squeeze.
– Private liquidity can offset public drain: Corporate cash balances, buybacks, and the growth of private credit and money-market intermediation can sustain risk-taking even as the Fed steps back.
– Watch the right gauges: The sign of trouble is not the size of the Fed’s balance sheet, but stress measures—cross-currency basis, bid-ask spreads in credit, commercial paper and repo rates, and the pace of reserve declines relative to bank demand.
The valuation and earnings arithmetic
The equity market’s sensitivity to rates is ultimately an interaction between earnings growth and the equity risk premium (ERP):
– Real rates versus earnings: If real rates rise because productivity and nominal GDP are firm, earnings growth can cushion multiples. Multiple compression of one or two turns on the market P/E is survivable if EPS is compounding at mid- to high-single digits.
– ERP can adjust: As policy credibility rises and tail-risk pricing falls, the ERP can drift lower without destabilizing the market, especially if cash flows are resilient and balance-sheet risk declines.
– Two-way volatility is not a bear market: Removing the “Fed put” raises realized volatility but can also reduce the probability of a catastrophic misallocation that ends cycles abruptly.
What could end the bull market instead
– An overtightening error: If policy drives real rates materially above neutral and keeps them there as the labor market deteriorates, the recession-bear nexus reappears.
– A balance-sheet accident: Hidden leverage in private credit, commercial real estate, or nonbank market-making could surface if funding costs jump too far, too fast.
– A fiscal or geopolitical shock: Disorderly Treasury supply dynamics, a loss of confidence in fiscal anchors, or an exogenous shock can swamp the otherwise-benign effects of rate normalization.
– An earnings recession: A profit squeeze from weakening demand, rising unit labor costs, or margin compression would matter more than the number of hikes.
Signals to monitor in a Warsh-led regime
– Labor and demand: Initial jobless claims, hours worked, and real retail sales.
– Credit conditions: Senior Loan Officer Survey, high-yield and IG spreads, bank funding costs.
– Curve and real rates: 2s10s steepness from the front end, and the 5y5y real rate versus the earnings yield.
– Liquidity stress: Usage of standing facilities, repo and bill market functioning, dollar funding spreads.
– Earnings breadth: Forward EPS revisions and the share of industries with rising estimates.
Bottom line
If Kevin Warsh were at the helm, a more orthodox, risk-aware tightening cycle would likely trade a bit more volatility today for fewer distortions tomorrow. That is not the stuff of a bull-market epitaph. Rate hikes can coexist with rising stocks when they are a byproduct of sturdy nominal growth, credible policy, and disciplined capital allocation. Bulls die from recessions, accidents, and profit slumps—not from normalization itself. Expect more rotation and less one-way momentum, but not an ending dictated solely by the level of the fed funds rate.
This analysis is for informational purposes only and not investment advice.
