In my last note, we talked about Warsh’s debut on the international stage, at the ECB Forum in Portugal, and the placating tone from Europe’s central bankers. “My friend Kevin,” as Lagarde put it.

That was the public posture.

Today, the Wall Street Journal gave us the private one. The front page carried the rupture with America: European leaders, behind closed doors, venting about Trump, tariffs, Greenland and the breakdown of the old alliance.

Some in the room reportedly called it “therapy night.”

Now let’s look at the behavior.

Last week, Europe met Trump’s July 4 trade deadline three days early.

The Turnberry Agreement (the U.S./Europe tariff agreement from last year) finally entered into force July 1. The terms: Europe accepted the 15% U.S. tariff cap on most European goods, and cut tariffs on U.S. industrial goods to zero.

For context, that bill had been frozen for the better part of a year. Once Trump put it on the clock, with a July 4 deadline, surprisingly the European bureaucratic machine got it done.

But the day after Europe complied, Trump attached the next condition: a 100% tariff on any country imposing a digital services tax on American technology companies, superseding any trade deal “whether implemented, signed, or not.”

Remember what this is all about: tariffs are about restructuring global trade and realigning the world (away from China, back toward the U.S.).

Europe has been a hold out, if not moving in the opposite direction.

With that, Trump is forcing compliance by using the U.S. position of strength.

He used access to the U.S. consumer as leverage to get the trade deal done with Europe. 

And for decades, Europe’s security rested on the U.S. balance sheet. America provided the backstop, and under that umbrella Europe built the welfare state, the regulatory state, the green transition and the euro project.

Now Trump has made that umbrella conditional.

And when the security guarantee becomes conditional, the bill moves onto European government balance sheets.

That happened today.

The Financial Times reported that Germany plans to borrow more than 800 billion euros by 2030, mainly for defense. 

This is big. This is Germany breaking its fiscal religion, because it has to.  As Germany’s finance minister said: “We can’t defend ourselves against Putin with the Schwarze Null.”

The question isn’t whether Germany can finance rearmament. The question is what happens when the whole continent has to contribute to this new security regime. These countries enter this regime with high debt, low growth, and fragile politics.

Let’s talk about yesterday’s central bank event in Europe.

On Wednesday, Kevin Warsh made his first international appearance as Fed Chair, on a panel at the ECB Forum alongside the heads of the ECB, the Bank of England, and the Bank of Canada.

The placating from his counterparts was unmistakable.

Lagarde volunteered Warsh’s policy philosophy as her own (highly agreeable with “my friend Kevin”).

On forward guidance — the “policy tool” of telling the market what you want it to do, and then making policy decisions based on what the market is doing — they all followed Warsh’s lead. And under the Warsh-led Fed, it’s over (no more forward guidance).  

No push back from anyone on stage.

Why such warmth and verbal alignment?

Remember, every one of Warsh’s counterparts on that stage runs a system that, in a crisis, needs access to dollars. Warsh holds the keys.

And no one needs those keys more than Europe.

Also remember, at this same forum a year ago, the conversation turned into a public airing of Europe’s core problem: it cannot fund its own fiscal ambitions. The sovereign debt and banking flaws exposed in the global financial crisis were never fixed, only papered over by the ECB. And the ECB could “paper over”/backstop the wobbling sovereign debt in the weak spots of Europe only to the extent that the Fed stood behind it, in coordination, with unlimited dollars accessible.

That coordination is what’s now in question.

Warsh has the Fed’s entire framework under review. He told the audience at this ECB forum that the Fed’s balance sheet “borders on fiscal policy” and needs to come “down to size.” A Fed stepping back from financing government debt is a Fed rethinking the whole backstop business.

So, for the central bankers of Europe, Britain, and Canada, when your ability to weather a storm depends on the world’s most powerful central bank, you tend to ingratiate yourself to the man that runs it. 

Stocks were bid again today, for a second straight session. The AI infrastructure names led the way: the chip and data-center stocks that sold off hard over the past two weeks are clawing it back.

Remember, last week some of the biggest winners in the AI trade were giving back gains ahead of Micron’s earnings. And as we discussed, instead of a signal that demand was cracking, it looked more like a positioning event (shaking out the unconvicted, late-to-the-party longs). Fast forward a week.  Micron earnings were a blowout. And the AI buildout trade remains intact.

Let’s talk about the yen.

The yen broke down today to the weakest level against the dollar since 1986. A forty-year low.

What does it mean? 

The official story on the weak yen has been Japan and the United States “coordinating closely” on the currency. Japan’s Finance Minister Satsuki Katayama and U.S. Treasury Secretary Bessent have been “talking.” They agree on “bold” and “decisive” action against disorderly currency moves.

And Japan actually intervened back in the spring, to prop up the yen. 

But the yen is weaker today than it was when Japan intervened. No action — even on the forty-year low.

So at this point, what they are enabling (both the U.S. and Japan) is a yen that keeps falling, in an orderly way. 

That begs the question: Is it about orderly decline, rather than stopping the decline?

For Japan, a weak yen is the only realistic way to manage the largest debt load in the developed world, north of 250% of GDP. Inflate it away. A cheap currency lifts exporters, lifts nominal growth, and erodes the real value of the debt over time.

For Washington, a stable, allied Japan with a cheap currency could serve as the manufacturing-and-technology offramp to soften the blow from a decoupling from China. If we think about the comments around last week talks between Bessent and Katayama, they were said to also touch on critical minerals, semiconductors, and keeping advanced AI out of the wrong hands.

So, coordination? Yes. To defend the yen? Unclear.  

What does it matter to us?

This is the funding engine of global risk-taking, running again. Cheap yen, borrowed and deployed into higher-returning assets around the world.

If the carry trade is rebuilding, global liquidity is flowing.

And in the last cycle, this kind of liquidity poured into crypto. Bitcoin was the high-beta expression of easy global money. This time, the funding engine is running and Bitcoin is going the other way, down roughly a third on the year.

So where does the carry money go now?

Into the real economy. Into chips, data centers, the power build-out, the physical layer of the AI boom. The speculative liquidity that used to chase digital assets is now financing real assets — infrastructure you can stand next to. It’s the same funding engine/ same liquidity machine, but different destination.

Which brings us to tomorrow.

Tomorrow morning, Kevin Warsh appears on a panel at the ECB Forum alongside Christine Lagarde (ECB), Andrew Bailey (BOE), and Tiff Macklem (BOC). The Fed’s role in global liquidity is likely to change under Warsh. His central bank counterparts have been bracing for a world where the implicit Fed backstop is no longer a guarantee.

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AI and chip stocks bounced back hard today, recovering some losses of the past two weeks.

The catalyst was news that SpaceX will be fast-tracked into the Nasdaq 100.

It’s a short trading week, with markets closed Friday for the Independence Day holiday. With that, the jobs report has been pulled forward to Thursday.

But the biggest event of the week may not be chips, SpaceX, or jobs. It may come from a stage in Portugal at the annual ECB Forum. Kevin Warsh (new Fed Chair) will appear Wednesday alongside his central banking counterparts from Europe, the UK, and Canada.

Remember, the last time we heard from Warsh, he had just chaired his first FOMC meeting and put the Fed’s entire policy framework under review. Everything is on the table, except the 2% inflation target (for now).

As we’ve discussed for the better part of the past year, since Trump first began turning up the heat on Jerome Powell (threatening to fire him), a new Trump-aligned Fed Chair was always likely to mean more than just a different approach to interest rates. It will likely mean the end of the Fed’s role as central banker to the world, the implicit global backstop that has stood behind the international financial system, particularly through dollar swap lines, for the better part of the last two decades.

And no region is more exposed to that regime change than Europe.

And with that, this week that exposure gets put on a stage in front of the world, at the ECB Forum.

A year ago, we talked about the outcome of the 2025 forum.

Markets were focused, at that time, on what Jerome Powell might signal about rate cuts.

But a more important topic emerged at that forum.

It was the solvency of Europe.

As Europe was faced (and still is) with large-scale fiscal expansion to fund defense, innovation (AI) and energy — the ECB Forum became a public airing of Europe’s inability to fund itself.

As we discussed last July, Europe’s large-scale fiscal spending plan can only work if the ECB monetizes the debt — backstopping the sovereign bond markets, particularly in fiscally weaker member states. But the ECB backstop only works when major global central banks are coordinating (namely the Fed). And under Warsh, the era of coordinated global monetary policy may be over.

With that, ECB President Christine Lagarde opened this year’s ECB Forum today, with a speech defending Europe’s resilience and the strength of its own policy toolkit. It was a speech clearly designed to project confidence to markets. But that confidence in its “tools” rests on the assumption that the ECB can maintain stability in the sovereign bond markets, as they have for the better part of the past fifteen years. 

And on Wednesday, Lagarde will share a stage with the man that may reshape the very backstop that her institution has relied on for fifteen years.

 

Back in early May, we walked through the playbook (then) Fed Governor Stephen Miran laid out on how Kevin Warsh can shrink the balance sheet without creating a liquidity shock.

Remember, the Jerome Powell-led Fed stopped and reversed on the balance sheet back in December.

And Powell said this in the post-meeeting press conference: “There’s a secular ongoing growth of the balance sheet. We have to keep reserves, call it, constant as it relates to the banking system or to the whole economy. And that alone calls for us to increase about $20 [or] $25 billion per month.“

So he said this new balance sheet expansion would be “ongoing,” meaning indefinite. 

If “ongoing” is indeed required to “keep reserves constant,” just to maintain stability in the funding markets, then how does Kevin Warsh step in and carry out his plan to shrink the balance sheet?

That was the point of that Miran speech last month.

He said the roughly three trillion dollars banks hold in reserves, which the Fed is afraid might become “scarce,” is not a reflection of what banks would choose to hold in a normal market. It’s a reflection of what they’re made to hold, in the post-Global Financial Crisis regulatory regime.

So, the top of Miran’s list of paths forward was to ease the GFC-induced over-regulation — ease the liquidity coverage ratio and the internal liquidity stress standards. 

Ease those rules, and the reserves can come down. Then Warsh can shrink the balance sheet without breaking funding markets. 

And then the capital that has been trapped in the banking system gets freed. 

And that capital gets freed in the form of pro-economic things like, loans to consumers and businesses. 

With all of this in mind, the results of the Fed’s annual bank stress test were released today. And they are “well positioned to weather a severe recession.”  The banks got an all-clear with room to spare.

And that all-clear signal was met, almost immediately, with announcement from major banks of dividend increases. Capital freed from the regulatory noose, and a wall of cash payouts starts.

This, on the same afternoon as the stress test results, should signal the regulatory regime is loosening, and credit growth is coming. 

And this comes on the same afternoon that Micron answered the questions about the durability of AI demand, unequivocally.

Revenue of $41 billion against $9 billion a year ago (not a typo).

Gross margins up 10 percentage points to 85%. 

Earnings per share more than doubling from last quarter.

Next-quarter revenue guidance of $50 billion, well above the Street. 

So two of the market’s standing fears were tested on the same day. One, the fear AI demand is rolling over. The other, a decade old, the fear that banks are permanently capital-constrained utilities.

Both were answered clearly within hours of each other.

We head into the week with the dollar testing 40-year highs against the yen and trading around 17-year highs against the Korean won (global financial crisis levels). Both central banks are defending their currencies, either with words, intervention, or both.

Meanwhile, the second most widely held currency in the world is trading around the lows of the past year, and looking vulnerable to a breakdown against the dollar.

Despite the new Fed Chair’s structural view on prices (lower, due to disinflationary forces from AI), the market is now pricing in a rate HIKE by year end, with a coin flips chance of TWO HIKES.

So, that market view on rising rates is fuel for the dollar.

But that’s short-term cyclical. The dollar breakout looks more like a structural capital flow regime, in the early stages.

Why? 

Dollars are in demand, to access: the U.S. AI boom, stronger U.S. growth, scarce commodities priced in dollars, the petrodollar (reinforced by America’s control over energy chokepoints), Treasuries, and now dollar stablecoins. 

On the latter, the Federal Reserve is holding its Fifth Conference on the International Roles of the U.S. Dollar, in Washington. Fed Governor Waller gave the opening remarks today.

This year’s conference is built around digital assets, especially dollar stablecoins, and what they mean for the dollar’s role in the world.

Remember, dollar stablecoins are backed primarily by U.S. Treasuries.  So, every dollar stablecoin issued is effectively another buyer of U.S. government debt. Scale them up globally (easy, frictionless access to dollars), and you hardwire global demand for dollars, and demand for Treasuries.

That cements the dollar’s dominance.

Also due to be presented at this conference tomorrow, is a study on foreign-currency funding risk. It lays out, in plain numbers, how the world will run short of a currency it can’t print. It’s talking about the dollar. 

And that’s of particular interest, because, as we know, Kevin Warsh (the new Fed Chair) wants to end the Fed’s QE business. Moreover, as we’ve discussed for the better part of the past year, the Warsh era will likely bring scarcer, more politically governed access to dollars (dollar swap lines).

With that, are we beginning to see the repricing of the dollar? From something the world had, and expected access to, to something more scarce, that is earned through political alignment?

Remember, pretty much everything is under review, as the new Fed Chair said last week. 

Yesterday Kevin Warsh declared the regime change at the Fed.

Today the market reacted. And it moved exactly in the direction the new regime points.

Gold down about 3%. The dollar firm. Stocks rose, led by chips. And the 10-year Treasury yield? It’s still hanging around 4.45% — familiar territory.

Remember, the consensus worry going into Warsh was that a Fed which stops telegraphing (no forward guidance, and in the case of yesterday, no dot from the chair) would leave the bond market unanchored and volatile.

Instead, the long end of the yield curve was among the steadiest of markets today.  This, the day after the new Fed Chair announced the entire framework at the Fed (on monetary policy) was under review for a rebuild.

On gold and the dollar: As we discussed last week, the move in gold from under $1,000 to over $5,000 mapped fifteen years of the Fed expanding its balance sheet. It’s been a quantity-of-money trade, not a rates trade.

And Warsh is looking to end that era: smaller balance sheet, taking the Fed’s thumb off the scale.

Gold falls, and the dollar firms, because the Fed getting out of the business of fiscal policy is good for the currency.

What about stocks?

Back in my May 18 note, we described the “Warsh doctrine:” smaller balance sheet and lower rates.  Lower rates, in his words, because “AI is going to make everything cost less.”

The traditional Fed raises rates to slow the economy down. Warsh thinks a wave of AI-driven productivity is growth positive and a structural disinflationary force.

With that, yesterday, in his first press conference, he called AI “American ingenuity.” And he told the room that strong, productivity-led growth is “not something that we fear, but something we embrace.”

So, the Fed Chair believes AI is a disinflation engine that lets him lower rates and shrink the balance sheet. And the market, the very next day, bid up the companies building that engine.

If Warsh is building his Fed around AI-led productivity, the market voted today in approval. 

For the better part of the past year, we’ve heard from Kevin Warsh on his views on the Fed, policy and the economy.

Smaller balance sheet. Lower rates, because “AI is going to make everything cost less.” Structural reform to break what he’s called “the entanglement” of the Fed with government financing.

And he took plenty of shots at the entrenched Fed regime along the way. The Fed’s hubris. Its failure to meet its price stability mandate for five straight years. The QE era it ushered in, and continued leaning on, as a crutch against its own (and Congress’s) bad policymaking. And the outcomes it manipulated through “forward guidance,” shaping market opinion with words and forecasts.

Then Warsh was named Fed Chair. And he told us what his Fed would look like: less manipulation, less telegraphing, more dissent, more volatility.

Today we got the first meeting.

First, he let his colleagues show where they stand. Not too surprisingly, the “dot plot” came in hawkish. His colleagues around the table took the opportunity to ratchet UP the rate outlook.

 

The committee did what the old Fed does. Calibrate the Fed funds rate, to the decimal, against a near-term, oil price/supply shock-driven rise in the inflation print.

Warsh encouraged them to submit their dots. He did not submit one of his own.

Then he told us why.

When he reviewed the submissions, he noted they all came in “with pencils, you know, those kind with the big erasers.” His point: his colleagues themselves didn’t feel bound by their own forecasts.

So, he revealed the old machinery of the Fed. And then he immediately announced he was putting all of it under review.

He announced five task forces. On Fed communications, including the dot plot. On the balance sheet. On the data the Fed relies on. On productivity and jobs in the age of AI. And on the inflation framework itself.

Every input of the old Fed reaction function is now on the table for a rebuild.

On the Fed’s “forward guidance” tool, Warsh has already deconstructed it. He considers it a circular reference.

The Fed signals hawkish. The 10-year yield ticks up. The Fed then points to the rising 10-year as evidence that the market sees inflation, and signals hawkish again … 

But the market wasn’t telling the Fed anything about the economy. It was reflecting the Fed’s own words back at it.

Moreover, with the constant noise of Fed voices, the market reacts not to the data, but to what we anticipate the Fed to say.

With that, the end of forward guidance may create a more stable market, not less. Markets price the data, not the Fed.

So, today’s meeting one wasn’t really about a policy decision. It was about the declaration of regime change at the Fed. 

Warsh has spent the past year telling us what he believed was broken. Today he let the old machinery show itself, the dots, the forecasts, the reflexive market and Fed feedback loop, and then put that machinery under review.

Sunday night the President announced the US–Iran agreement. “Complete,” with signing staged for Friday, and a reopening of the Strait of Hormuz.

Markets had a familiar response on yet another peace headline. Oil fell about 5% to the low $80s. Equities ripped, globally. 

What are the details of the “deal?” And what does it mean? 

The U.S. is reopening the Strait. That means the oil flows, because Washington decides it flows. It’s a waterway that now runs at America’s discretion.

So, as we discussed last week, a deal doesn’t mean withdrawal. It means control.

With that, in my last note, we revisited how this relates to Europe.

And this morning, Von der Leyen (European Commission President) issued her statement on the deal.

She welcomed the agreement, “following sustained diplomatic efforts by several partners.”

Keep in mind, the partners consulted in the deal Trump telegraphed last week did not include the European Union.

Then she made a request: “Freedom of navigation must be restored toll-free.”

So, Europe wasn’t a party to the agreement that governs its own energy lifeline. And it’s now petitioning for terms on relief it doesn’t control. 

With that, as we discussed in my Thursday note: “relief for Europe runs through Washington.”  And that means the U.S. is leveraging Europe’s energy dependency to force political alignment.  

And Von der Leyen called it out, saying “energy dependencies have been weaponized.” 

And Trump’s leverage just became stronger over the past week, the European Central Bank raised rates into rising inflation and weakening growth — brought to them by the energy shock.

Which brings us to Wednesday.

Kevin Warsh chairs his first Fed meeting this week. Just as Europe is becoming more and more vulnerable to financial stress, Warsh should be beginning the end of the era of globally coordinated central banking. That means dollar liquidity for Europe becomes conditional.

As we discussed over the past several months, providing “access to dollars” (via swap lines) is a bargaining chip for the Trump administration to incent policy and geopolitical alignment.  And Warsh set the table for it back in his April Congressional hearing — indicating that this swap line issue was a government and Fed collaboration (issues of “international finance”).