"Interest rate cuts + balance sheet reduction + reform"! Walsh's "three-pronged approach for the Fed"—whether it's real or not, will be revealed soon.

Kevin Warsh, after nearly a decade of waiting, has finally won Trump’s nomination for Federal Reserve Chair. However, the new leader will soon face his first real test: whether his promised “rate cuts, balance sheet reduction, and institutional reform” actually have room for execution. During his campaign, Warsh emphasized that “the Fed needs a regime change,” advocating for controlling inflation while shrinking the balance sheet and pushing structural reforms to create conditions for lower interest rates. But the real-world environment is far from easy. ## Market Pricing First: No Short-Term Bet on Rate Cuts After three rate cuts at the end of last year, the Fed hit pause in January 2026. Facing stubborn inflation, a stabilizing labor market, and expectations of stronger growth in 2026, market sentiment has reversed. **Rates markets are now much more cautious. Traders' pricing shows the earliest next rate cut won’t happen until June this year.** Dario Perkins, an economist at macro consultancy TS Lombard, said bluntly: > “Once theory is tested in reality, the cost is often personal reputation. For him, this is like a ‘winner’s curse.’” ## "Balance Sheet Reduction" May Be Just Cover for Rate Cuts A core plank of Warsh’s platform is to **accelerate reduction of the Fed’s balance sheet** while cutting rates, to ease inflationary pressure. But this logic has sparked debate in markets. Rabobank macro strategist Stefan Koopman remarked: > “It’s a plan that looks tough but also provides cover for future rate cuts.” Markets fear that if inflation doesn’t ease, **“Rate cuts plus balance sheet reduction” could actually tighten financial conditions** and weaken the policy’s effectiveness. Whether Warsh’s "three-pronged" strategy works will depend not only on his intent, but also on macro data. ## The AI Productivity Assumption as a Key Premise Warsh’s central support for his policy is the judgment of **AI-driven productivity gains**. He explained his approach in detail in a November Wall Street Journal op-ed: > **“Fundamental reforms in monetary and regulatory policy will unleash AI’s benefits for all Americans... Inflation will further decline.”** On a podcast in December, Warsh said more bluntly: > **“This is the greatest wave to boost productivity in our lifetimes—past, present, and future.”** This means that, **even if the economy stays resilient, inflation may be contained by greater efficiency, opening room for rate cuts.** But this premise remains contentious. Peter Conti-Brown, a University of Pennsylvania professor and Fed historian, called the argument “**overly optimistic**.” ## Forced Rate Cuts Could Trigger Bond Market Turmoil Warsh faces a major challenge: regardless of White House pressure, rate decisions are made by a majority of votes on the Federal Open Market Committee (FOMC), and the Chair only gets one vote. Even the well-regarded Jerome Powell faced fierce resistance when seeking a third consecutive rate cut in December last year. If the macro environment (like a weak labor market or falling inflation) doesn’t cooperate, Warsh’s push for rate cuts will face huge opposition. Donald Kohn, a former Fed vice chair who worked with Warsh during the 2008 financial crisis, said: “He knows he’ll need to use his considerable skills to marshall evidence and analysis to support the policy direction he wants.” **Analysts warn that if Warsh gives in to White House demands for rate cuts without data support, the market could protest by selling bonds, leading bond yields—and real borrowing rates—to surge. This would run counter to Trump’s goal of lowering borrowing costs.** ## Real Room for Action May Lie in “Reform,” Not Rates If Warsh can’t quickly get majority FOMC support for rates policy, he may turn to structural reforms at the Fed in cooperation with the White House. Currently, the Department of Justice is conducting an unprecedented investigation into cost overruns in Fed headquarters renovations, heightening market fears that the administration is trying to remold the central bank. Treasury Secretary Scott Bessent has also suggested changing eligibility for regional Fed presidents. Sarah Binder, a political science professor at George Washington University, pointed out that even if reforms aren’t fully successful, attempts are coming. Regarding Fed internal structure, Warsh has much more power than over rates decisions. Mark Spindel, co-author of “The Myth of Independence,” cautioned investors to watch the shift in power: **“The Chair has great control over staff and which research questions get asked and answered... They can basically engineer the replacement of certain regional Fed presidents.”** This means that even if short-term rate policy stalls, the Fed under Warsh may undergo profound changes in regulation, personnel, and institutional structure—a “second battlefield” long-term investors need to watch closely. Risk Warning and Disclaimer The market has risks, investments need caution. This article does not constitute personal investment advice, nor does it take into account special investment objectives, financial circumstances or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article fit their specific situation. Invest accordingly at your own risk.