The Warsh Paradox

Kevin Warsh isn't slated to take over as Federal Reserve (Fed) chair until May, but his views on the size of the central bank's balance sheet have already unsettled markets. On Sunday, Treasury Secretary Scott Bessent sought to calm nerves, suggesting the Fed would take at least a year before making any decisions and that Warsh would be "very independent."

The accord question

Warsh has floated the idea of a new Fed-Treasury "accord", a modern version of the 1951 agreement that ended the Fed's wartime policy of capping Treasury yields. He has suggested such an accord could spell out the Fed's intended balance sheet size, with the Treasury laying out its debt-issuance plans in coordination.

What this might mean in practice remains unclear but given the ongoing anxiety about Fed independence under this administration, markets will be watching closely for any signs of political capture or balance sheet moves.

Hawk turned dove

While the accord proposal raises complex structural questions for the medium term, Warsh’s immediate priority appears to be straightforward monetary easing

He has historically been viewed as a hawk. However, recent comments suggest he has become far more dovish when it comes to rates. Over the past year, he has said that high interest rates are weighing on growth and job creation. In addition, he has downplayed risks of a resurgence in inflation, arguing that AI-driven productivity is a “significant deflationary force” which he believes justifies looser monetary policy.

In other words: expect rate cuts. The fact that inflation is well above target is unlikely to be an obstacle. And frankly, the data will likely “light the way” to rate cuts even for hawks. The labour market is weakening and economic data is likely to deteriorate in the coming months, which will justify cuts for most, if not all, FOMC members.

Balance sheet scare

It was Warsh's views on the Fed’s balance sheet, rather than his current rate views, that spooked markets last week. He criticised QE back in 2010, calling the risks "unknown, uncertain and potentially large." Even though he articulated opposition to QE2 while on the FOMC, he ultimately voted for it, explaining that he didn't want to undermine then-Chair Ben Bernanke's efforts to tackle the crisis. As recently as November 2025, he wrote a Wall Street Journal op-ed describing the Fed's balance sheet as "bloated" and arguing it could be "reduced significantly."

But aggressively shrinking the balance sheet would undermine efforts to ease policy. It would push up long-term rates, raise mortgage costs (running counter to the administration's goal of lowering them), and potentially trigger a stock market selloff if done too quickly.

The San Francisco Fed's proxy fed funds rate illustrates how balance sheet policy can work against rate decisions. In late 2024 and early 2025, while the Fed was in easing mode, the 'real feel' of the fed funds rate was actually higher than the actual rate because of quantitative tightening.

Figure 1. When the Fed was easing in 2024/25, the 'real feel' didn't follow

Source: San Francisco Federal Reserve, Bloomberg from 19 December 2008 to 30 January 2026.

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Even before Bessent's weekend comments, our view was that markets appeared to be unjustifiably nervous about what a Warsh Fed would mean for monetary policy. The data will not support a reduction in the balance sheet and it would undermine his intention to support the economy. 

Independence, relatively speaking.

There are degrees of independence. Warsh has the credentials to satisfy markets that the Fed remains credible. He served on the FOMC from 2006 to 2011, sat through the Global Financial Crisis, and was the Board's representative to the G-20.

That said, he is the son-in-law of Ronald Lauder, a billionaire, longtime Trump friend and major donor. (Lauder is reportedly the person who first suggested US President Donald Trump acquire Greenland.) So, while Warsh will maintain the veneer of independence, he may have some interest in keeping the President happy.

A few wrinkles

The economic outlook is filled with uncertainty given tariffs and other geopolitical risks. And current Chair Jay Powell has yet to say whether he will remain on the Board of Governors until his term ends in January 2028. If he stays, that could complicate Warsh's leadership of the FOMC.

Republican senator Thom Tillis has warned he will not vote for any Fed nominees until the Department of Justice's case against the Fed has been closed. That could slow the timeline for when Warsh actually assumes his new role.

Our bottom line

Warsh was the better of the realistic options. Expect rate cuts. Don't expect aggressive balance sheet reduction, at least not early in his term.  And watch carefully his efforts to allay any market concerns about the erosion of Fed independence.

All data sourced from Bloomberg unless otherwise stated. 

Author: Kristina Hooper, Chief Market Strategist at Man Group.

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