Dongwu Securities: Is the new Federal Reserve Chair Powell really hawkish?

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Source: Macro fans哲

Key Takeaways

Key Takeaways: We believe the market has a cognitive misunderstanding in its hawkish interpretation of Warsh. Based on the latest view, Warsh has already turned dovish on monetary policy. Judging from the nomination reasons, Trump will only choose a Federal Reserve chair who is willing to cut interest rates. From the feasibility of a hawkish stance, the current liquidity environment does not support the Fed shrinking its balance sheet. Therefore, we expect that after Warsh takes office as Fed chair, he will implement more rate cuts than the market expects within a reasonable range of the Taylor Rule. In terms of timing, the Fed may begin a sequence of consecutive cuts in June. The total number of cuts for the year will be 75–100 bps. As a result, yields on short-term U.S. Treasuries may decline significantly, while yields on long-term U.S. Treasuries will continue rising due to the term premium being pushed up by the reversal brought by the “Warsh trade.”

Trump nominated Warsh as the next chair of the Federal Reserve, and the market is trading a hawkish expectation based on “inertia thinking.” On January 30, Trump announced the nomination of Warsh (Kevin Warsh) as the next Fed chair. During Warsh’s tenure as a Fed governor from 2006 to 2011, he was hawkish. Even at the peak of the 2008 financial crisis, he continued to emphasize that inflation should be the Fed’s main concern. Meanwhile, he has long advocated reducing the Fed’s assets and liabilities balance sheet. He argued that a large balance sheet is excessive interference with market mechanisms and could disrupt price signals. His balance-sheet reduction stance and his strong attention to inflation previously led the market to generally view Warsh as a hawkish chair, trading the narrative of “hawkish policy expectations + restoring independence,” with the U.S. dollar and U.S. Treasury yields rising and gold and other precious metals falling sharply. But we believe that from three perspectives—the latest view, the nomination reasons, and the feasibility of a hawkish approach—the market’s hawkish interpretation of Warsh falls under “inertia thinking.” After taking office, he will still be a dovish Fed chair.

Latest View: Warsh has already turned dovish on monetary policy. Although Warsh, during his earlier time as a Fed governor, was more hawkish than other governors, since 2025 he has shifted to a dovish stance in monetary policy. Specifically, Warsh believes that productivity gains brought by AI will not lead to inflation, so the Fed does not need to curb economic growth by imposing restrictive interest rates. And the Fed’s current bloated balance sheet, in essence, was designed to respond to the post-crisis era that is already long gone, to support the largest financial institutions. Its scale can be reduced substantially. Overall, Warsh believes that inflation comes from excessive government spending and an overabundance of money issuance. The policy space released by “balance-sheet reduction” would allow the Fed to cut rates further, thereby reallocating funds back to the household sector and small and medium-sized enterprises through lower interest-rate mechanisms.

Nomination Reasons: Trump will only choose a Fed chair who is willing to cut rates. Trump’s primary consideration in selecting a Fed chair is whether they can cut rates quickly. If Warsh cannot meet that standard, Trump has no motivation to choose him as the next Fed chair. In addition, Warsh and Trump have a strong personal relationship. Warsh is the son-in-law of Ronald Lauder, heir of the Estée Lauder family. Lauder has had more than 60 years of personal friendship with Trump, and according to Federal Election Commission (FEC) data, since 2016 Lauder’s total donations to Trump’s team have been 6–8 million USD, providing significant support for Trump’s campaign. This close “personal connection” also makes Warsh more inclined to keep “in sync” with Trump when executing monetary policy.

Feasibility of a Hawkish Stance: The current liquidity environment does not support the Fed shrinking its balance sheet. We believe Warsh’s balance-sheet reduction argument has more to do with expressing his opposition to former Fed eras—including Powell, Yellen, and even the unrestrained expansion of the Fed’s balance sheet during the Bernanke era—rather than something driven by liquidity necessity. The background for the lightweight “balance-sheet expansion” RMP launched by the Fed last December was that the current U.S. dollar liquidity situation faces exhaustion of the reverse repo “buffer,” and the use of liquidity tools for reverse repos is becoming increasingly frequent. Bank reserves have also begun to face real impact as balance-sheet reduction progresses. In such an environment, the Fed’s essence in activating the RMP is to avoid a potential liquidity crisis in the repo market. If, after Warsh takes office, he immediately begins balance-sheet reduction and triggers a liquidity crisis like the one in 2019, it would be very unfavorable for the smooth implementation of his subsequent policies.

Outlook: Warsh’s nomination still needs to be reviewed by the Senate, and the tail risk of Powell’s “retiring but not resting” remains. Before Warsh officially takes office as Fed chair, he still needs to go through the Senate Banking Committee review and obtain approval by a simple majority vote before being submitted to the full Senate for a roll-call vote. Currently, there are 13 Republican members and 11 Democratic members in the Senate Banking Committee. On the surface, Trump still holds an advantage in votes. However, several Republicans on the Senate Banking Committee have recently expressed dissatisfaction with Trump’s interference in the Fed’s independence. For example, Tom Tillis said he would not agree to any Fed personnel nomination by Trump before the conclusion of any criminal investigation into Powell. Therefore, to ensure Warsh can smoothly pass the Senate review and voting stages, he still needs to maintain his “independence” image before formally succeeding Powell, whose term as chair runs out on May 15. At the same time, the market has also begun to gradually pay attention to the possibility that, after Powell steps down as chair, he may remain as a governor and continue to influence the Fed’s policy direction (for details, see the report “Taking Lessons from History: How Big Are the Tail Risks of Powell Becoming the Fed’s ‘Viceroy’?”). Trump therefore needs Warsh to maintain the “independence” label before formally taking office, to reduce the likelihood of Powell keeping a remaining role as a governor under the pretext of defending the Fed’s independence, thereby further strengthening Trump’s control over monetary policy.

Market Implications: The “Warsh trade” may continue flipping until Warsh officially takes office in May. As mentioned earlier, because Warsh will still maintain an appearance of independence before his official taking office, the current “Warsh trade” may extend into February–April. The market may still need to wait until after Warsh officially becomes Fed chair to truly recognize whether he is “hawkish in appearance but dovish in reality.” Looking ahead, although Warsh in the future will lean toward staying “in sync” with Trump on monetary policy, it is also difficult for the Fed to genuinely return to the 1970s Fed chair situation where it “obeys the president’s orders only.” Warsh’s path of rate cuts still needs to follow the guidance of the Taylor Rule framework (for details, see the report “Technical Thread: How Does the Fed Decide to Hike or Cut Rates?”). Therefore, we believe that after Warsh takes office, he will lower interest rates as much as possible within the limits allowed by the Taylor Rule. We expect the Fed to begin consecutive rate cuts in June. The total annual amount of cuts will be 75–100 bps (3–4 cuts), exceeding the market’s current expectation of two annual cuts. By then, yields on short-term U.S. Treasuries may fall sharply, while yields on long-term U.S. Treasuries will keep rising as the term premium is pushed up by the reversal in trading.

Risk Warning: After Warsh takes office as chair, the Fed’s monetary policy may exceed expectations; Trump may interfere again with the Fed’s personnel agenda through administrative means; the market’s reaction to Trump’s interference with independence may be less than expected.

The above is part of the report content. For the complete report, please see “Is the New Fed Chair Warsh Really Hawkish?”

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