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”). 

 

We’ve talked in recent weeks about the “Venezuela model” as the ultimate outcome for Iran.

Take the Iranian oil.  Sell it at market rates. The money goes into a U.S. Treasury-controlled account — removing the revenue lifeblood from the regime, reserving the money for reconstruction, and the U.S. controlling key global oil supply in the process.

Rubio detailed the mechanism at the cabinet meeting a couple of weeks ago. Then both Rubio and Bessent described their half of the architecture, in their respective congressional testimonies last week.

Today Trump said it explicitly. He said in the not too distant future, the U.S. would take Kharg Island (the terminal behind roughly 90% of Iran’s crude exports) and “assume total control of their oil and gas markets, much like we have with Venezuela.”

The oil can flow, but not on the old terms, and not back to the old hands.

So, a deal, in this framework, doesn’t mean withdrawal. It means control. 

And with that, this afternoon, Trump announced (yet another) “deal” is near …

 

This cancellation of more strikes resulted in yet another relief episode for markets — another sentiment massage (stocks up, yields down, oil down).  

Notice within this post, the coalition of countries Trump named: the United States, Israel, Saudi Arabia, UAE, Qatar, Turkey, Pakistan, Bahrain, Kuwait, Jordan, Egypt.

Notice Europe wasn’t mentioned. The energy shock that just drove the ECB to a rate hike this morning is being negotiated without their participation.

With that, let’s revisit this excerpt from my May 19 note…

Scott Bessent was in Paris, delivering the keynote at the No Money for Terror conference. He told the room of global policymakers and financiers this:

 

“The United States is hardly alone in facing the scourge of terrorism, especially from Iran. Yet, too often, we seem to be alone in our resolve to thwart it.” 

 

He then called on Europe, by name, to take action and expose Iran’s financing networks — unmask shell and front companies, shutter bank branches, dismantle proxies.

 

And he called on partners in the Middle East and Asia to root out Iran’s shadow banking networks (the China-Iran financial pipeline).

 

But this “alone in our resolve” statement was clearly aimed at Europe, along with “no room for excuses.”

 

We’ve talked about the Trump plan to restructure global trade and realign the world (away from China, back toward the U.S.), anchored by “burden sharing” — where allies and trading partners pay for access to safety (U.S. security guarantees), stability (the dollar and U.S. capital markets), and markets (U.S. consumers).

 

These are all no longer automatic, but conditional — conditional based upon alignment. 

 

And Bessent is making it clear that alignment includes: designate, expose, shutter, and dismantle Iran’s financing.

 

Or, stay ambiguous, as Europe has to this point, and discover what “conditional” looks like in practice.

 

And we’ve talked about the levers that Trump, Bessent and the new Fed Chair can pull to force political alignment — through consequence, not argument.

With this, “force political alignment through consequence” tactic in mind:  If a “deal” on Iran is coming, it still wouldn’t resolve the energy shock for Europe soon enough. Qatari LNG wouldn’t normalize for years. And the ECB’s own staff admitted last week that energy pass-through to utility bills takes “several months.”

And with Kharg on the table, relief for Europe runs through Washington. U.S. LNG and crude, Iranian barrels through a Treasury architecture, Qatari volumes returning.

Fair to say, relief comes with alignment. 

Don’t forget, Europe sits on the Trump-imposed July 4th deadline for a trade deal.

This morning we got May CPI. Hot, as expected: 4.2% on the headline, up from 3.8%.

As we discussed in Monday’s note, with the effective fed funds rate sitting around 3.62%, real rates just went more negative — now roughly minus 0.6%. The deepest negative real rate since 2023.

Now, here’s the chart of the day …

A significant technical trendline in gold broke today. This is the trendline that defined the runup over the past 17 months of the Trump presidency.

The textbook says that shouldn’t happen. Gold loves negative real rates. The deeper they go, the better it tends to do — because the policy intent behind negative real rates is typically to promote risk taking (move people out of bonds and into of higher-return assets, to overcome the drag of inflation against purchasing power). Gold tends to go up as an inflation hedge (a contra-dollar/contra-paper currency).

That said, today real rates went deeper negative than they’ve been in three years, and yet gold broke support, continuing its slide — now down close to 30% from the highs.

There are two reasonable explanations: 1) The rate market is pricing about 70% odds of a Fed hike by year-end, so gold may be trading the expectation that today’s negative real rates won’t be around for long.

And 2) the war uncertainty premium may be subsiding — the parabolic runup in gold from September was, in large part, a war bid, and this week the whole complex is unwinding together: silver down double digits, platinum down 8%, crude down 7%, dollar up.

Both sound reasonable. But if we step back, there is also a bigger story the chart may be telling.

Gold traded below $1,000 coming out of the Global Financial Crisis. It peaked this year above $5,000. We should acknowledge that the five-fold run in gold maps against fifteen years of central bank balance sheet expansion (QE, deficit underwriting, the Fed absorbing the Treasury market).

And remember, Kevin Warsh, under oath in April, called it what it is: “fiscal policy in disguise.”

An inflation in asset prices, including gold, defined that era. It wasn’t a rates trade. It was a quantity of money trade.

They printed more money, the nominal price of stuff went up. Gold, the asset with a history of offering protection against such debasement of the currency, among them.  

That all makes today interesting.

Warsh chairs his first Fed meeting in seven days.

His stated direction for policy (the one we walked through Monday) is to end the “disguise.” It’s to extract the Fed from fiscal policy, shrink the balance sheet, and pair it with lower rates.

If that regime change is real. If it’s going to happen. Then an engine of the gold bull is getting turned off. And under that lens, gold can fall while rates fall.

So if the regime story is right, gold is falling on anticipation, pricing Warsh’s credibility to do what he says he’s going to do. But, to be sure, there are a lot of obstacles (and likely internal opposition at the Fed) to work through in order to get the Fed regime change (policy and cultural) underway. 

June 17 is the first test. 

In my February 18 note, we called the race for AI supremacy a two-horse race, winner-take-all, and “very, very tight.”

Four months later, that statement still holds.

Today Anthropic released Fable 5 to the public. This is the guardrailed version of Mythos. 

Remember, Mythos is the Anthropic model we discussed in April that found and exploited decades-old security flaws on its own. It was deemed so capable they didn’t release it, and instead took it to the government and convened industry leaders to start building protection against it.

That said, around 1pm this afternoon, they announced the release of Fable 5 as the “safe” version of Mythos.

Stocks bottomed right around that time, after what was becoming another messy unwinding day for AI stocks.

So now we have another big leap forward in model capabilities — maybe the most consequential since the early February models that brought the explosion in agentic AI.

With that, the read over the past half year or so has been that — Anthropic is king, AGI is near (if not here), the U.S. has won the AI race. 

But this chart says otherwise. 

This tracks the “Intelligence Index” of the world’s top AI models (the dots).  Notice, the U.S. models are on top. But what’s clear, is that the dots are clustering tighter and tighter as the model intelligence is rising.

The frontier isn’t separating, it’s converging. OpenAI, Anthropic, Google, xAI are bunched together at the top. And the Chinese labs –DeepSeek, Alibaba, Kimi have compressed the gap, not widened it.

What’s the finish line? 

Human-level intelligence, that becomes self-improving.

The first to that finish line should be the winner, and therefore, should be in position to set standards, attract talent, and determine what technology gets embedded into governments and critical infrastructure.

And as we’ve said before, that will mean the difference between AI that serves humanity, or AI that controls humanity (serving the interest of the Chinese Communist Party).

Is Mythos (and today’s publicly available model, Fable) the model that reaches the finish line?

Maybe. Consider this: Anthropic preceded today’s model release with a note last Thursday titled, When AI builds itself (see it here).

And Anthropic’s founder Dario Amodei had already described Mythos a few months ago as “by far the most powerful AI we’ve ever built.” Around that time, he also did a podcast where he said, the surprising thing isn’t how fast they’re accelerating, it’s “how close we are to the end of the exponential.”

Not the start. The end. He’s saying the steep part of the climb is nearly behind us.

If he’s right, the convergence on that chart above may not be a pause before someone breaks away. It may be the field arriving near the finish line together.

So, still a tight race.

Which is why China is a significant threat. One Chinese model leap doesn’t have far to travel.

 

We get the May jobs report tomorrow.

For the better part of the past two years, we watched this report for “cracks in the labor market” which was the explicit condition named by the Fed — it would force the Fed’s hand.

Weak jobs meant rate cuts.

So, markets were on high alert the first Friday of every month.

That era/regime is largely behind us.

The shift came back in December. Remember, the jobs report due that month was postponed by a government shutdown. When it was finally reported mid-month, it showed the unemployment rate jumping to 4.6%.

It was the highest level in four years, and yet the market barely flinched.

Why?  The Fed had already pivoted.

The Fed cut rates for a third consecutive time earlier that month, and had turned the liquidity spigot back on (returned to expanding the balance sheet).

The conditionality of the jobs report was supplanted by signs of financial instability (some stress in the money markets) and cooling inflation.

That brings us to tomorrow’s report. 

First, rates. The story now isn’t whether a soft print triggers a rate cut. In fact, at the moment, the market is pricing in the chance of a rate hike by year-end. 

But what matters now, under a Warsh-led Fed, is getting the Fed out of the way of an economy that has pro-growth policy behind it and a technology revolution running through it. It’s a structural tailwind.

Second, the jobs number itself is communicating a different message. Under the Trump administration, government headcount is being cut while private hiring is coming back (chart below). 

 

So, for the headline payroll number, a “soft” headline could actually be a healthy rotation: fewer government jobs, more productive private ones. The composition matters maybe more than the total.

The old question was “will this scare the Fed into cutting?” The better question now, and in the coming months: “is the private economy growing, and is AI-driven productive work showing up in companies, that leads to more hiring, to drive more productive work …?”