The Fed is facing its most significant leadership change in decades. With Warsh comes not just a new person, but a different understanding of what a central bank should do. Kevin Warsh – a former member of the Fed’s Board of Governors and a close confidant of President Trump – replaced Jerome Powell as Fed chair in May. What at first glance appears to be a personnel change is, in reality, a paradigm shift: Warsh represents a fundamentally different vision of how monetary policy should work.
Interest rates and the balance sheet: A bew package
The first and most important distinguishing feature concerns the relationship between interest rate policy and balance sheet policy. Powell analytically separated interest rate and balance sheet policies: cuts on the short end, continued QT on the long end (QT = Quantitative Tightening: the Fed shrinks its balance sheet by not replacing maturing bonds, thereby withdrawing liquidity from the market.). Warsh flips the script. His program calls for lower interest rates and a smaller balance sheet – as a package. In an op-ed in the Wall Street Journal in November 2025, he put it this way: “The Fed’s bloated balance sheet can be significantly reduced. This generosity can be redistributed in the form of lower interest rates to support households and small and medium-sized businesses.” He elaborated on CNBC in July: “If the printing press could be silenced, we’d have lower key interest rates.”
Another theory of inflation
Linked to this is a second, fundamental difference: the diagnosis of inflation. The diagnosis of inflation is also shifting. Powell followed the classic Phillips curve model: too much growth, too high wages. (The Phillips curve describes the classic assumption that low unemployment leads to rising wages and thus to inflation.) Warsh flips this on its head: “Inflation arises when the government spends too much and prints too much money.” He views AI as a disinflationary shock – that is, as a force that tends to push prices down rather than drive them up: Q3 2025 productivity at an annualized rate of 4.9%, compared to the 50-year average of 1.9%, supports his thesis, at least in some respects.
New Treasury-Fed agreement
In addition to monetary policy, Warsh is pursuing a second, institutional agenda – one that is at least as far-reaching: a new Treasury-Fed agreement modeled after the 1951 agreement (The 1951 agreement ended a period during which the Fed was required to purchase Treasury bonds at fixed prices to keep war debt manageable – it restored the central bank’s independence.). Warsh on CNBC in July 2025: “We need a new Treasury-Fed agreement, like the one we had in 1951 after another period in which we had built up our country’s debt and were left with a central bank that was working against the interests of the Treasury.” This is not a matter of technical detail. Such an agreement would alter the Treasury’s issuance structure (i.e., change which maturities of government bonds are newly issued) and could drastically reduce supply at the long end – by shifting new issuances to the short end, by refraining from issuing long maturities, and by coordinating control over what the market is actually allowed to buy.
Implications for markets and investors
What does all this mean for investors and markets? For the markets, this creates an unusual scenario. At first glance, lower balance sheet totals combined with lower short-term interest rates would suggest a bear steepener – meaning short-term rates fall, long-term rates rise, the yield curve steepens, and shifts in a direction that is unfavorable for bond investors. However, if supply at the long end is simultaneously reduced on a massive scale, the picture changes: artificial scarcity at the long end (i.e., for bonds with long remaining maturities) meets structural demand, and long-term yields can fall despite expansionary monetary policy. It is precisely this scenario that justifies a constructive positioning in long duration – that is, an exposure to long-term bonds whose value rises when long-term yields fall – not in spite of, but because of Warsh’s program.
Two Conditions, Two Risks
The scenario is plausible, but it depends on two conditions – and both are uncertain. Whether it comes to pass depends less on his monetary policy program than on whether the market believes in the new inflation model and whether the Treasury-Fed agreement remains politically viable. Anyone who underestimates these two hurdles underestimates the risk of the entire thesis.
Note: This text was translated using AI and may contain translation errors. The German version of the text is authoritative.