Who is Kevin Warsh?

On 30 January the White House nominated Kevin Warsh, a former Federal Reserve governor, to succeed Jerome Powell as Fed chairman. The choice caught markets off guard and sent investors back to their forecasts for the Fed's balance sheet and interest rates. Powell's term as chairman ends in May, and the Senate must confirm his successor before then for the handover to be smooth.

A governor who left over QE

Warsh is no stranger to the institution he would run. He joined the Board of Governors in 2006 after serving in the Bush White House, sat through the financial crisis as the board's main link to Wall Street, and resigned in 2011 amid disagreement over the second round of bond buying. Since then, from the Hoover Institution at Stanford, he has been one of the most persistent critics of the Fed's reliance on asset purchases, forward guidance and what he regards as an excessive faith in economic models.

His route to the board was unusual. Before Washington he was a mergers banker at Morgan Stanley, and he arrived at the Fed at 35, the youngest governor in its history. He was on the shortlist in 2017, when the president chose Powell instead, so the nomination closes a circle more than it breaks new ground. A chair must also sit on the Board of Governors, which means the Senate is confirming him to a seat as well as to the top job.

Smaller balance sheet, lower rates

Warsh mixes monetary conservatism with a supply-sider's pragmatism. He has long criticised quantitative easing after the financial crisis and the growth of the Fed's holdings, arguing that a big central bank portfolio distorts asset prices, crowds out private capital and makes it easier for governments to overspend. The working assumption among Fed watchers is a trade: fast shrinking of the Fed's $6.5 trillion balance sheet in return for lower policy rates. He has also argued that a jump in productivity could let rates fall without reviving inflation, which gives the White House the cuts it wants and gives Warsh a principled reason to deliver them.

He inherits a committee already in easing mode. The Fed cut by a quarter-point at each of its last three meetings of 2025, taking the federal funds range to 3.50–3.75 per cent, and it did so over dissents from both sides. A chair who wants faster cuts is pushing on a door that is half open, but the balance sheet is another matter, because the committee spent 2025 slowing and then ending its runoff after holdings had peaked at close to $9 trillion in 2022.

How the trade would work

The two halves act on different ends of the yield curve. A lower federal funds rate pulls down Treasury bill yields and the rates on floating-rate loans almost at once. Shrinking the balance sheet works through the long end: when the Fed lets bonds mature without replacing them, or sells mortgage-backed securities outright, private investors must absorb more duration, and they demand a higher term premium to do so. The Fed only halted its last round of shrinkage in December, so a new one would reverse a decision the committee has barely finished implementing.

The curve steepens

The Treasury curve steepened sharply. Short-term rates fell as traders priced in cuts sooner, while long-dated yields rose on the prospect of the Fed withdrawing support for the bond market. A steeper curve helps banks, which borrow short and lend long, and floating-rate borrowers such as leveraged companies. It hurts homebuyers, because American mortgage rates track the ten-year yield rather than the policy rate, and it raises the Treasury's cost of issuing long-term debt at a time of large deficits.

The bond market has shown before how quickly it reacts to talk of withdrawing support. In May 2013 Ben Bernanke merely suggested that the Fed might slow its purchases, and over the following months the ten-year yield rose by more than a percentage point, dragging mortgage rates up with it. That episode, the taper tantrum, involved slower buying rather than outright sales, which is why a chair who favours active shrinkage has to prepare markets with care.

Limits on a smaller Fed

The case against the consensus rests on plumbing. In September 2019, after two years of balance-sheet reduction, overnight repo rates spiked when bank reserves ran short, and the Fed had to start buying Treasury bills again within weeks. Any fresh shrinkage would need changes to bank liquidity rules or a larger standing repo facility to avoid a repeat, and those take time. The chairman is also one vote among twelve on the Federal Open Market Committee, and several members will resist rate cuts while inflation stays above the 2 per cent target.

Demand for reserves has also grown since then. Banks now hold large reserve balances partly because liquidity rules written after 2008 reward them for doing so, and the standing repo facility created in 2021 has so far been used sparingly, since banks worry that tapping it signals weakness. Unless regulators change those incentives, the floor under the balance sheet sits higher than a Warsh-led committee might wish.

Who sets policy

There is a political angle too. Warsh has talked about a new accord between the Fed and the Treasury, echoing the 1951 agreement that freed the central bank from pegging bond yields, and a formal deal over the size of the balance sheet could make markets wonder who sets policy. The markers to watch are his confirmation hearing before the Senate Banking Committee, any detail he gives on the pace of runoff and the treatment of mortgage bonds, and the Treasury's choice between issuing more bills or more long-dated debt.

The irony of that precedent is hard to miss. The accord of 1951 was a declaration of independence, signed after the Fed refused to keep financing wartime debt at fixed rates. An accord struck now, with a chair chosen partly for his willingness to cut, would run in the opposite direction, and the term premium on long bonds is where investors would register any doubt. Under Warsh, investors should expect cheaper short-term money and a Fed selling down its bond holdings. Long-dated yields will probably carry more of the burden once he takes over.