After a wait of nearly a decade, Kevin Warsh has finally secured former President Trump's nomination for Federal Reserve Chair. However, the new leader will soon face his first reality check: whether his promised "interest rate cuts, balance sheet reduction, and institutional reform" has genuine room for execution. During the nomination process, Warsh emphasized the "need for a regime change at the Fed": advocating for creating conditions for lower interest rates by shrinking the balance sheet and promoting structural reforms, all while controlling inflation. Yet, the real-world environment is far from accommodating. Market pricing is taking the lead, with no near-term bets on rate cuts. Following three rate cuts late last year, the Fed hit the pause button in January 2026. Confronted with stubborn inflation, a stabilizing labor market, and expectations for stronger growth in 2026, market sentiment has reversed. The interest rate market is adopting a more cautious stance, with traders' current pricing indicating the next rate cut won't occur until June of this year at the earliest. Dario Perkins, an economist at macro consultancy TS Lombard, stated bluntly:
"When theory is tested against reality, the cost is often personal reputation. For him, this seems like a 'winner's curse'."
"Balance sheet reduction" might merely serve as cover for rate cuts. One of Warsh's core proposals is to accelerate the reduction of the Fed's balance sheet while pushing for interest rate cuts, aiming to lessen inflationary stimulus. However, this logic has sparked disagreement within the market. Rabobank macro strategist Stefan Koopman pointed out:
"This is a plan that appears hawkish while also providing cover for future rate cuts."
The market worries that if inflationary pressures do not recede significantly, the combination of "rate cuts + balance sheet reduction" could inadvertently tighten financial conditions and weaken the policy's effectiveness. Whether Warsh's "triple play" can be implemented depends not only on his willingness but, crucially, on the cooperation of macroeconomic data. The AI productivity hypothesis emerges as a key prerequisite. The core support Warsh provides for his policy framework is his assessment of AI-driven productivity gains. He elaborated on his approach in a November Wall Street Journal op-ed:
"Fundamental reforms to monetary and regulatory policy will unleash the benefits of AI for all Americans... inflation will fall further."
Warsh was even more direct in a December podcast, stating:
"This is the most productivity-enhancing wave in our lifetimes—past, present, and future."
This judgment implies that even if the economy remains resilient, inflation could be controlled through efficiency gains, thereby opening the door for rate cuts. Yet, this premise remains contentious. University of Pennsylvania professor and Fed historian Peter Conti-Brown characterized the related arguments as "overly optimistic." Forcing rate cuts risks triggering bond market turmoil. Warsh's greatest challenge lies in the fact that, regardless of pressure from the White House, interest rate decisions can only be made by a majority vote of the Federal Open Market Committee (FOMC), where the chair holds just one vote. Even the widely respected Jerome Powell faced intense challenges when seeking a third consecutive rate cut last December. If the macroeconomic environment—such as labor market weakness or a decline in inflation—does not cooperate, Warsh would face significant resistance in forcefully pushing for rate cuts. Donald Kohn, a former Fed Vice Chair who worked with Warsh during the 2008 financial crisis, noted, "He knows he needs to use his considerable and excellent skills to marshal the evidence and analysis to support the policy direction he wants to take." Analysts warn that if Warsh yields to White House demands for rate cuts without supporting data, the market might express its dissent by selling bonds, potentially causing bond yields—and consequently real borrowing costs—to surge. This outcome would run counter to Trump's goal of reducing borrowing costs. What might be truly actionable is "reform," not interest rates. If unable to quickly secure majority FOMC support for interest rate policy, Warsh might take a different path, collaborating with the White House on structural reforms for the Fed. Currently, the U.S. Department of Justice is conducting an unprecedented investigation into cost overruns for the Fed headquarters renovation, intensifying market concerns about the executive branch's attempts to reshape the central bank. Treasury Secretary Scott Bessent has also suggested altering the qualification requirements for selecting regional Fed presidents. Sarah Binder, a political science professor at George Washington University, indicated that even if reforms are not entirely successful, attempts are forthcoming. Regarding the Fed's internal structure, Warsh possesses greater control than he does over interest rate decisions. Mark Spindel, co-author of "The Myth of Independence," advises investors to watch the shift in influence: "The chair has a lot of control over the staffing of the committee and which research questions get asked and answered... They can essentially engineer the replacement of certain regional Fed presidents." This means that even if near-term interest rate policy faces obstacles, the Fed under Warsh's leadership could undergo profound changes in regulation, personnel, and institutional structure, representing a "second front" that long-term investors need to monitor closely.
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