Trump expects his Fed chair nominee to cut interest rates. Here's how Kevin Warsh might try to do it.

MW Trump expects his Fed chair nominee to cut interest rates. Here's how Kevin Warsh might try to do it.

By Greg Robb

Warsh will be pressed on his outlook for rates at his Senate confirmation hearing Tuesday

Kevin Warsh may argue that shrinking the Fed's balance sheet by $1 trillion calls for a rate cut of 50 basis points to keep the economy on a steady path.

When President Donald Trump selected Kevin Warsh to be the next head of the Federal Reserve, the conventional wisdom was that Warsh must have somehow convinced the president that he would be able to persuade his fellow central bankers to lower interest rates.

But how?

It's been clear for months that there's not much support for lowering rates among the 19 top Fed policymakers. Stephen Miran, the Fed governor with the closest ties to the Trump White House, has been a lonely voice calling for deep rate cuts.

But there is one way Warsh might be planning to get Fed officials to go along with monetary-policy easing, according to economists: by shrinking the Fed's balance sheet.

Warsh's previous speeches suggest he believes that shrinking the balance sheet by $1 trillion has an effect on the economy equivalent to an interest-rate hike of 50 basis points.

Warsh will press his Fed colleagues to cut short-term rates to offset such a tightening of the balance sheet, said Joe Gagnon, a fellow at the Peterson Institute for International Economics.

Essentially, Warsh would be tightening policy with one hand while easing with the other. But it would get interest rates down.

"Shrinking the balance sheet may indeed be an argument Warsh leans into as to why rates should be lower," said Mark Cabana, head of U.S. rates strategy at BofA Global Research.

Warsh has been a vocal critic of the size of the central bank's balance sheet, which has ballooned to over $6 trillion, up from under $1 trillion before the 2008 financial crisis.

The Fed now holds $1.6 trillion in long-term Treasurys and $1.9 trillion in mortgage-backed securities. This is a large "footprint" in financial markets.

"If you're holding [mortgage-backed securities] and super-long-term treasuries, then you are holding down the yields on those assets relative to where they would otherwise be," Gagnon said.

Miran, who is Trump's main ally at the Fed, has recently voiced support for this exact policy.

In a speech calling on the Fed to shrink its balance sheet, Miran said that the economic effects of balance-sheet reduction "can be offset with a lower federal-funds rate."

"It is therefore likely that a resumption of balance-sheet reduction warrants additional reductions in the federal-funds rate relative to baseline projections," he said.

The federal-funds rate is the formal name for the Fed's benchmark interest rate.

Gagnon, who was a top Fed staffer before joining Peterson, said that in lobbying to become Fed chair, Warsh might have told Trump that he sees a way to lower the federal-funds rate by 100 basis points. About 50 basis points of that drop would come in response to shrinking the balance sheet, and Warsh might argue that the other 50 basis points in cuts could come after the higher inflation resulting from tariffs and the war in Iran eases.

Warsh will be pressed about his thoughts on the outlook for interest rates on Tuesday, when the Senate Banking Committee holds a hearing weighing his confirmation as Fed chair. Lawmakers will focus on whether Warsh is going to be truly independent or whether he's just going to do what the president wants him to do.

A spokesperson for Warsh declined to comment.

Warsh will be under pressure to lower rates

In January, Trump picked Warsh over four other candidates to replace outgoing Fed Chair Jerome Powell.

Warsh served as a Fed governor from 2006 until 2011 and has been a consistent critic of the central bank's policies ever since.

During his first term as president, Trump considered Warsh for Fed chair but passed him over in favor of Powell, a decision the president has often said he regrets. Powell's term as chair ends in May.

Significant roadblocks to Warsh's Senate confirmation remain, but whenever he does finally take the reins at the Fed, he will be under tremendous pressure from the White House to bring interest rates down.

Earlier this week, Trump repeated his assertion that interest rates should be much lower than the current range of 3.5% to 3.75%.

Asked during an interview on Fox Business Network if he thought rates would go lower later this year, Trump replied: "When Kevin gets in, I do."

The president has joked that he would sue Warsh if the Fed didn't cut rates sharply.

But many Fed officials have said they're wary of cutting rates until there's progress on bringing inflation closer to the central bank's 2% target. The war in Iran has boosted inflation to the highest level in two years, making officials even more cautious.

What is the Fed's balance sheet?

Ben Bernanke pioneered the use of the balance sheet in 2008, during his term as Fed chair. In the midst of the financial crisis, the Fed had lowered rates to zero, but it still wasn't enough to stimulate the economy. So the central bank bought long-term Treasurys and mortgage-backed securities to help get interest rates down and spark a recovery.

These assets were matched by liabilities - reserves held by banks in accounts at the Fed. The Fed pays the banks interest on these reserves.

The Fed has tried to shrink its balance sheet two times in recent years. The first effort ended with a market meltdown in 2019, with rates spiking in money markets. The second effort started in 2022 and ended more calmly last December, but with the balance sheet at $6.6 trillion, higher even than at the 2017 peak.

Gagnon said Powell and his colleagues have never come up with a good way to communicate overall monetary policy, including the balance sheet.

Fed officials have preferred to keep the balance-sheet program in the background. They've often referred to it as watching paint dry.

"They really talk as if the balance sheet is one thing and setting interest rates is another thing, and they don't talk about the interconnections between the two," Gagnon said.

"What's on the balance sheet does affect the stance of policy, and they should integrate it into their overall analysis, and they refuse to do that," he added.

Since starting to use the balance sheet in 2008, the Fed has not sold any assets. Rather, it has reduced the balance sheet by waiting until the assets it holds mature and then not reinvesting the proceeds of the maturing assets.

This strategy has left the Fed with a large amount of mortgage assets. But the strategy of slowly rolling off maturing assets doesn't work the same way for mortgage-backed securities, because most of those are low-rate loans that homeowners are not likely to prepay, meaning that they won't mature for decades.

Warsh's two choices for shrinking the balance sheet

The Fed has two choices for shrinking its balance sheet, Cabana at BofA Global Research said.

First, it could announce the sale of assets on the open market. It's highly doubtful this will happen, he said.

"Selling assets would be extremely disruptive to financial markets. It would tighten financial conditions and result in notably lower risk-asset values," he said.

Although a slower economy would potentially justify lower rates, the cost would be high.

"I don't think Trump would sign up for that at all," Cabana said.

In his speech last month, Fed governor Miran said he would support selling some securities if they were trading at a profit. But Cabana said he didn't think other Fed officials would agree.

"It would be very surprising to markets if the Fed tried to crystallize gains. Most experts would tell you it's highly unlikely. I would tell you it is highly unlikely," Cabana said.

The more plausible option, he said, would be that the Fed would focus on the liability side of its balance sheet - the $3 trillion in reserves that banks hold at the Fed.

Banks keep reserves in part to meet liquidity standards that were put in place after the 2008 financial crisis.

Reserves are a useful form of liquidity for banks, said Darrell Duffie, a finance professor at Stanford Graduate School of Business. They are very short-term and liquid.

"When a bank needs money in a hurry, that can help banks through a liquidity crunch," he said on a Brookings Institution podcast.

The Fed wants banks to hold ample reserves. At the same time, it is sensitive to the amount of interest that it pays commercial banks on their deposits, Duffie said, as this often gets portrayed as a giveaway for banks.

"It's not a great look, at least to some, and including some in Congress, that large banks are getting paid a lot of interest by the Fed," Duffie said. But there is not really a cost to this, he noted, because banks would get the same amount of interest from holding short-term Treasury bills.

Cleveland Fed President Beth Hammack, in an interview on CNBC on Wednesday, said the Fed is trying to balance the financial-stability benefits of ample reserves with some of the reputational benefits of having a smaller balance sheet.

In a speech in February, Fed governor Christopher Waller put it more colorfully: "You don't want banks every night ... digging around the couch cushions looking for money. That is massively inefficient, stupid."

But lowering the need for reserves has its limits.

"We can only take the balance sheet down so much if banks continue to demand reserves," Hammack said.

Lou Crandall, chief economist at Wrightson ICAP, a research firm that specializes in the Fed, said the central bank is making progress on exploring possible options to wean banks off holding too much in their reserves.

There has been discussion of reforming post-2008 liquidity rules that give incentives for banks to hold reserves while setting up programs to ensure that banks would have access to emergency funds when they are needed.

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April 18, 2026 09:00 ET (13:00 GMT)

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