Deutsche Bank analysis suggests that if Kevin Warsh becomes the next Federal Reserve Chair, his policy approach may feature a unique combination of simultaneous interest rate cuts and balance sheet reduction.
On December 16, reports indicated that former Fed Governor Kevin Warsh has emerged as a leading candidate for the Fed chair position alongside Kevin Hassett, according to statements made by former President Trump during a media interview. Trump remarked, "I think both Kevins are great."
This statement caused Hassett's odds to drop significantly on prediction markets. As of Tuesday, Polymarket data showed Warsh with higher probability than Hassett to become the next Fed chair.
On December 15, Deutsche Bank's Matthew Luzzetti team published research analyzing Warsh's potential policy positions. The report suggests that if appointed, Warsh would likely support rate cuts while simultaneously pushing for balance sheet reduction. However, the feasibility of this "dual approach" depends on regulatory reforms reducing banks' reserve requirements - a questionable prospect in the short term.
The report emphasizes that markets should closely watch whether a new chair can maintain independence amid political pressure for aggressive rate cuts and how policy credibility will be established.
Warsh's Background: Unlike economist Hassett, Warsh comes from a legal background with extensive experience in both public and private sectors. He served as Fed Governor from 2006-2011 during the global financial crisis, acting as a key liaison between the Fed and markets. He has been sharply critical of the Fed's aggressive balance sheet operations over the past 15 years, arguing that quantitative easing strayed from the central bank's core mandate.
Currently a partner at Duquesne Family Office and visiting scholar at Stanford, Warsh's cross-sector experience gives him deep understanding of financial markets and monetary policy.
Warsh's Views on QE: Deutsche Bank notes Warsh has criticized the Fed on both short-term policy decisions and long-term strategy. While he supported initial QE during the crisis, he warned against continued easing, citing inflation risks and mission creep. He resigned from the Fed in 2011 opposing QE2, stating it inappropriately entangled the Fed in fiscal policy during economic recovery.
Warsh believes aggressive balance sheet use created a "monetary dominance" era, where artificially low rates facilitated government debt accumulation.
Other Policy Critiques: Warsh has criticized the Fed's data dependence, forward guidance, and certain analytical frameworks. He questions the Fed's expanding mandate into areas like climate policy and argues the institution has undermined its own independence through poor performance and mission creep.
Near-Term Policy Implications: While recently advocating for rate cuts, Deutsche Bank notes Warsh isn't structurally dovish. His crisis-era views were often more hawkish, particularly on balance sheet issues. Any rate cuts under Warsh might come alongside balance sheet reduction, though this would require regulatory changes to reduce reserve requirements - an uncertain prospect.
The report concludes that regardless of Trump's choice, markets will test the new chair's independence and inflation-fighting credibility. With Trump pushing for aggressive easing and a divided FOMC, Deutsche Bank doubts immediate policy shifts, advising investors to expect gradual adjustments rather than abrupt changes.
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