Federal Reserve leadership is about to change—how will this affect major asset classes?

Once again, the market has made a knee-jerk misinterpretation of the Fed's actions. On January 30, 2026, Trump officially nominated Kevin Warsh as the next Chairman of the Federal Reserve. Wall Street's immediate reaction was panic: the US dollar surged, US stocks fell, and precious metals were sold off. The reason was simple—Warsh was labeled as a "hawk" by the market.

On February 4, Shenwan Hongyuan analyzed in a research report that the market is making the mistake of pricing in changes too quickly. Warsh is not a traditional hawk; his core policy is a "balance sheet reduction + interest rate cut" hybrid—curbing long-term inflation expectations by reducing the balance sheet, thereby opening space for sharp rate cuts. For investors, this means the short-term liquidity panic may be an overreaction. Under the political pressure of the 2026 mid-term elections and the heavy burden of US fiscal interest expenditure, rate cuts are highly likely to happen before balance sheet reduction. Investors should not be scared off by short-term volatility, but should focus on US stock style rotation (large-cap to small-cap), opportunities to enter the market when precious metal volatility normalizes, and the secondary inflation risk from oil prices due to geopolitical factors.

Misreading “Hawkishness”: Warsh's True Intention Is to Pave the Way for Rate Cuts

The report points out that the market’s first reaction to Warsh’s nomination was tightening panic, but this ignores the integrity of his policy proposals. While Warsh stresses the need for the Fed to reduce its bloated $7 trillion balance sheet, this is not to choke the economy.

On the contrary, Warsh believes that current high interest rates do not account for productivity improvements brought by AI. His logical conclusion is: Only by eliminating the “Fed put” and long-term inflation expectations with balance sheet reduction does the Fed have the confidence to cut rates sharply. He even advocates institutional reform for the Fed, to break free from the dogma of the 2% inflation target. So, investors are facing a chairman who seeks to reshape monetary policy through supply-side logic (productivity revolution), not just a rate-killer.

Harsh Reality: Political and Fiscal Pressure Force “Rate Cuts First, Balance Sheet Reduction Later”

Shenwan Hongyuan believes that although Warsh wants to shrink the balance sheet, real data shows the Fed cannot be tough in the short term.

Liquidity exhaustion risk: Liquidity in US money markets is at a critical point. Reserve balances have dropped sharply, and overnight reverse repo (ONRRP) usage is basically zero. Aggressive balance sheet reduction now would only spark severe disruptions in the repo market.

The fiscal deficit “curse”: 2024 data shows interest payments already account for 18% of US federal fiscal spending. If long-term rates spiral out of control, the Treasury faces disastrous debt repayment pressure. Term premium for US debt is hard to lower; if the Fed sells Treasuries, it will be shooting itself in the foot.

Midterm election political iron law: 2026 is a midterm election year, with Trump’s approval rating at a low level. Historically, the incumbent party is very likely to lose seats in midterm elections. To win votes, the Trump administration urgently needs an accommodative monetary environment to support the economy and employment.

Therefore, the report judges: Before the midterm elections, the most realistic choice for the Fed is only rate cuts, while balance sheet reduction will be a long-term process.

US Equity Strategy: Turbulence and Style Rotation Under High Valuation

The core problem US stocks currently face is "expensiveness". The S&P 500 dynamic PE is as high as 22x, at the 86th percentile historically. Although profit growth is expected to exceed 15% in 2025-2026, high valuations require robust earnings to be justified.

Warsh’s nomination has increased short-term market volatility, but also brought style rotation opportunities. If Warsh pushes the “small government + banking ease” model, small-cap stocks (such as Russell 2000), which have badly underperformed large caps over the past few years, will see valuation repair. The Russell 2000’s valuation relative to the S&P 500 is at a historical low (21.2% percentile). With a fix in the liquidity logic, mid/small-cap, manufacturing, and financial stocks may be more attractive than crowded large-cap growth stocks.

Precious Metals and Commodities: Long-term Logic Intact, Waiting for Volatility to Normalize

Hit by both signals of “US-Iran peace talks” and Warsh’s nomination, gold and silver have dropped sharply recently. But this is more of a speculative sell-off, not a collapse of long-term logic. The global “de-dollarization” trend and safe-haven demand remain the cornerstone for a long bull market in precious metals.

From a trading perspective, implied volatility for gold and silver futures is still at an historical extreme. The report recommends investors be patient—wait for volatility to retreat and for put/call ratios to hit bottom and rebound, which will be the best time to enter.

As for oil, anchored to gold prices, oil is currently extremely undervalued. Though Trump tends to suppress oil prices to control inflation, geopolitics remain as a black swan. If oil prices break $80/barrel in the second half of 2026, the US will face “re-inflation” risk and macro asset allocation logic will change dramatically again.

Risk Warning and DisclaimerThe market has risks, and investment requires caution. This article does not constitute personal investment advice, nor does it take into account the individual user's special investment goals, financial situation, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article apply to their specific circumstances. Investment decisions based on this article are the user's own responsibility.