The market has once again exhibited a knee-jerk misinterpretation of the Federal Reserve's actions. On January 30, 2026, former President Trump formally nominated Kevin Warsh as the next Chair of the Federal Reserve. Wall Street's initial reaction was one of panic: the U.S. dollar surged, U.S. stocks declined, and precious metals faced a sell-off. The reason was simple; the market labeled Warsh as a "hawk."
On February 4, analysis from a Shenwan Hongyuan report suggested that the market is making the mistake of pricing in changes too quickly. Warsh is not a traditional hawk; his core policy stance is a hybrid of "balance sheet reduction + interest rate cuts" – aiming to curb long-term inflation expectations by shrinking the balance sheet, thereby creating room for significant rate cuts. For investors, this implies that the short-term liquidity panic might be an overreaction. Given the political pressure from the 2026 midterm elections and the heavy burden of U.S. fiscal interest payments, interest rate cuts are highly likely to materialize before balance sheet reduction. Investors should not be deterred by short-term volatility but should instead focus on opportunities arising from a potential style shift in U.S. stocks (from large-cap to small-cap), the re-emergence of volatility in precious metals, and the risk of secondary inflation in crude oil prices due to geopolitical factors.
**Misreading the 'Hawk': Warsh's True Intent is to Pave the Way for Rate Cuts** The report points out that the market's initial reaction to Warsh's nomination was a fear of tightening, but this overlooks the completeness of his policy stance. Although Warsh emphasizes that the Fed must reduce its bloated $7 trillion balance sheet, this is not intended to stifle the economy. Conversely, Warsh believes current high interest rates fail to account for productivity gains driven by AI. His logical framework is that only by eliminating the "Fed put" and long-term inflation expectations through balance sheet reduction can the Fed confidently implement substantial rate cuts. He even advocates for institutional reform at the Fed to move away from the rigid 2% inflation target. Therefore, investors are facing a Chair who seeks to reshape monetary policy through a supply-side logic (productivity transformation), not merely a rate hike enforcer.
**Harsh Reality: Political and Fiscal Pressures Force 'Rate Cuts First, QT Later'** Shenwan Hongyuan argues that although Warsh desires balance sheet reduction, real-world data suggests the Fed lacks the leverage for aggressive action in the short term.
* **Liquidity Drain Risk:** Liquidity in the U.S. money market has reached a critical point. Reserve balances have declined significantly, and the usage of the Overnight Reverse Repo Facility (ON RRP) has essentially dropped to zero. Aggressive quantitative tightening (QT) at this juncture would only trigger severe turbulence in the repo market. * **The Constraint of Fiscal Deficit:** Data from 2024 shows that interest payments already accounted for 18% of U.S. federal expenditures. If long-end interest rates spiral out of control, the U.S. Treasury would face disastrous debt servicing pressure. The term premium on U.S. Treasuries is more likely to rise than fall; if the Fed were to sell Treasuries, it would be counterproductive for the Treasury. * **The Political Imperative of Midterm Elections:** 2026 is a midterm election year, and former President Trump's approval ratings are low. Historically, the party in power is highly likely to lose seats in midterm elections. To secure votes, the Trump administration urgently needs an accommodative monetary environment to support the economy and employment.
Consequently, the report concludes that before the midterm elections, the Fed's most pragmatic option is likely to be interest rate cuts, with balance sheet reduction being a prolonged process.
**U.S. Stock Strategy: Volatility Amid High Valuations and Style Shifts** The core issue facing U.S. stocks currently is their high valuation. The S&P 500's forward P/E ratio stands at 22x, placing it in the 86th percentile historically. Although earnings growth expectations for 2025-2026 exceed 15%, high valuations require strong earnings validation. Warsh's nomination has increased market volatility in the short term but also presents opportunities for style rotation. If Warsh promotes a "small government + bank deregulation" model, small-cap stocks (such as those in the Russell 2000), which have significantly underperformed large-caps in recent years, could experience a valuation rebound. The valuation of the Russell 2000 relative to the S&P 500 is at a historically low level (21.2nd percentile). As liquidity dynamics adjust, small and mid-caps, manufacturing, and financial stocks may become more attractive than crowded large-cap growth stocks.
**Precious Metals & Commodities: Long-Term Thesis Intact, Awaiting Volatility Normalization** Gold and silver have recently sold off sharply due to a combination of "U.S.-Iran negotiation" signals and Warsh's nomination. However, this appears more driven by speculative positioning unwinding rather than a breakdown in their long-term investment case. The global trend of "de-dollarization" and safe-haven demand remain the foundational supports for a long-term bull market in precious metals. From a trading perspective, the implied volatility for Shanghai gold and silver futures remains at extreme historical highs. The report advises investors to remain patient, suggesting that the optimal time for positioning may be after volatility subsides and the put/call open interest ratio shows signs of bottoming and rising.
Regarding crude oil, if priced relative to gold, oil is currently in a deeply undervalued zone. Although Trump may prefer to suppress oil prices to control inflation, geopolitics remain a potential black swan. If oil prices breach $80 per barrel in the second half of 2026, the U.S. could face "re-inflation" risks, which would once again drastically alter the logic for macro asset allocation.
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