As of April 26, 2026, Kevin Warsh’s path to becoming Chair of the Federal Reserve has become much clearer than it was a few weeks ago. Jerome Powell remains the current Chair, with his term running until May 15, 2026; Warsh appeared at the Senate hearing on April 21, 2026, and after the U.S. Department of Justice ended its investigation into Powell on April 24, 2026, Senator Thom Tillis also stopped blocking Warsh’s confirmation process on April 26, 2026.

In other words, what the market now truly needs to think about is no longer “whether Warsh will take office,” but rather: what the first policy equilibrium will look like after Warsh takes office.

Many commentaries tend to simplify the issue into a single question: will Warsh be more hawkish or more dovish than Powell? But this way of asking the question is too static and too superficial. The real question should be: how a newly appointed Chair nominated by Trump, under the triple pressure of White House demands for rate cuts, bond market demands for credibility, and the Fed’s own requirement for institutional independence, would design a policy mix that is acceptable to the market and defensible politically.

My view is that the most likely path for Warsh is neither purely balance-sheet driven nor purely rate-cut driven, but rather a compromise: “partial rate cuts + balance-sheet offset.” In other words, what he is most likely to do is not to take sides directly, but to use limited rate cuts to respond to Trump’s political demands, while using a more active balance-sheet reduction to maintain institutional credibility, anchor inflation, and provide some counterbalance to overall financial conditions.

The core of this judgment is not conspiracy thinking, but game theory. Trump is unlikely to nominate someone completely indistinguishable from Powell who ignores his preferences; but once Warsh takes the Chair, he cannot answer only to Trump—he must also answer to the bond market, inflation expectations, and the historical positioning of the Federal Reserve. Therefore, the most reasonable equilibrium is neither full compliance with the White House nor deliberate confrontation, but rather: 

Deliver part of the rate cuts Trump wants, while using another tool to reduce the institutional cost.

1. Trump’s “reasonable rate” is likely an aggressive opening

To understand Warsh’s policy space, we must first understand what Trump considers a “reasonable rate.”

Public information shows that Trump’s recent demands on Fed rates have been quite aggressive. He has publicly argued:

  • The federal funds rate should fall to around 1%;
  • Or at least be 2 to 3 percentage points lower than current levels;
  • He has also directly called for a 100 basis point cut in one move.

Given the current policy rate, these statements are clearly not a baseline scenario that technocrats would naturally accept. They are closer to a typical Trump-style opening move: set a very high demand, force the market and counterparties to react, and then settle in a lower range that can still be framed as a victory.

As of March 18, 2026, the Fed maintained the federal funds target range at 3.50%–3.75%, with IORB at 3.65%. Compared to this, Trump is effectively calling for a policy shift that is far below current levels and, given the current backdrop of employment, inflation, and geopolitical risk, is quite aggressive.

Therefore, Trump’s public stance can be understood as a negotiation anchor; but this does not mean that the range he can ultimately accept is equally extreme. A more reasonable inference is that what Trump truly wants may not be an immediate move of the federal funds rate down to 1%, but rather to at least see that the Fed has clearly begun cutting rates, and that overall borrowing conditions visibly ease.

In other words, what Trump cares about may not simply be the final level of short-term rates, but whether:

  • The Fed has started to move downward;
  • Long-term rates are under control;
  • The market believes that after the change in leadership, the policy direction is indeed more accommodative than in the Powell era.

From this perspective, there is likely a large gap between Trump’s public opening bid and the “settlement price” he may actually be willing to accept. A more reasonable inference is not that he truly needs the federal funds rate to fall to 1% immediately, but that a lower yet still defensible range, such as 2.5%–3.25%, may be closer to the level that would be acceptable in a final political bargain.

2. Why Warsh may not turn aggressively hawkish on day one

Many people’s first reaction to Warsh is that he will place more emphasis on balance-sheet reduction and institutional credibility than Powell, and therefore naturally equate him with a more hawkish Chair. But this judgment only captures half of the picture.

The key issue is: even if Warsh has a hawkish preference, would he choose to deploy it at full force immediately upon taking office, especially at a time close to midterm elections? I do not think so.

There are three reasons.

2.1. Trump’s pressure for rate cuts will not suddenly disappear on Warsh

Trump has long publicly criticized Powell precisely because he believed Powell did not align with his preference for lower rates. If Trump actively nominates Warsh, the natural inference is that Warsh’s policy reaction function should at least be closer to a range acceptable to the White House. Otherwise, the political meaning of the nomination would be significantly weakened.

2.2. Warsh still needs to establish his own institutional legitimacy

Even so, Warsh cannot simply comply from day one. For a new Chair, one of the biggest risks is being perceived by the market as “the person brought in by Trump to cut rates.” Therefore, he cannot only satisfy the White House; he must also convince the bond market that he is not merely executing politically driven easing.

2.3. Policy timing around midterm elections may differ

If we introduce the time dimension, a more reasonable interpretation is that Warsh may not immediately turn strongly hawkish upon taking office; instead, he is more likely to retain flexibility before the midterm elections and strike a balance between rate cuts and balance-sheet reduction. In other words, Warsh’s hawkish inclination is more likely a medium-term direction, rather than a maximum-force move right at the start of his tenure.

3. The most likely base case: partial rate cuts + balance-sheet offset

This is the scenario I think deserves to be placed at the center of the base case.

The core logic is simple: Trump needs to see rate cuts; Warsh needs to preserve credibility; and the market needs to believe that the Fed is not simply accommodating politics. Under these three constraints, the most reasonable policy design is this:

  • Rates can be cut, but not to the level Trump has publicly demanded;
  • Rate cuts can happen, but they will be limited and framed as data-driven;
  • At the same time, they can be paired with balance-sheet reduction, a smaller Fed balance sheet, and a reduced Fed role in markets, in order to offset part of the easing effect.

This actually fits very well with Trump’s usual negotiation pattern: start with a high demand, then settle in a lower range that can still be claimed as a victory. Applied to monetary policy, this means Trump publicly demands aggressive rate cuts, but what Warsh actually delivers may only be part of that. In exchange, Warsh would place more emphasis on balance-sheet reduction, institutional normalization, and the idea that the Fed should not remain a long-term hidden support for markets and fiscal financing.

For Trump, this is enough to say that “changing leadership worked”; for Warsh, it is enough to show that “I am not simply adding liquidity, but restructuring the policy mix”; and for the market, it is easier to accept than nakedly political rate cuts.

Impact on the broader economy

Under this scenario, the U.S. economy is most likely to enter a more complex, and even somewhat distorted, financial environment:

  • Short-term rates fall, improving market sentiment in the short term;
  • But long-term rates may not fall in parallel, and may even rise;
  • Treasury issuance, corporate financing, AI capital expenditure, power investment, and infrastructure investment may still compete within the same pool of capital;
  • Risk assets may initially welcome the rate-cut signal, but if the market realizes that balance-sheet reduction is still continuing, or even begins to worry that inflation tolerance is rising, the follow-through may not be smooth.

Why would there be a situation where short-term rates fall, but long-term rates do not necessarily fall? The reason is that long-term rates do not only reflect the current policy rate. They also reflect the market’s judgment on future inflation, fiscal supply, term premium, and Fed credibility.

If Warsh cuts rates on one side, while maintaining or even accelerating balance-sheet reduction on the other, the market may face two opposing forces at the same time: on one hand, lower short-term rates theoretically help overall financing conditions; on the other hand, balance-sheet reduction means the market has to absorb more Treasury risk. If investors also suspect that the Fed is becoming more tolerant of inflation, term premium may rise, causing long-term rates to stay elevated or even move higher.

So this is not a traditional full dovish pivot. It is closer to this: short-term rates respond to political pressure, while long-term rates answer to the market’s judgment on inflation, fiscal conditions, and Fed credibility.

4. Can this combination work quantitatively? How much balance-sheet reduction is needed for every 25bp cut?

If Warsh really takes the path of “partial rate cuts + balance-sheet offset,” the biggest question is not the direction, but rather: is the scale large enough, and can the market absorb it?

A 2022 Federal Reserve study pointed out that if the Fed’s holdings of 10-year equivalent Treasuries were permanently reduced by an amount equal to 1% of nominal GDP, it would roughly raise the 10-year Treasury term premium by about 10 basis points. In model terms, this is broadly equivalent to the federal funds rate being 10 basis points higher.

If we use U.S. nominal GDP of roughly $30 trillion as a rough estimate, 1% of GDP is about $300 billion. From this, we can get a common-sense sense of scale:

  • For every 10bp rate cut, roughly $300 billion of “effective balance-sheet reduction” would be needed to offset it;
  • For every 25bp rate cut, roughly $750 billion would be needed;
  • For every 50bp rate cut, roughly $1.5 trillion would be needed;
  • For every 100bp rate cut, roughly $3 trillion would be needed.

Three points need to be emphasized here.

First, this is a sense of scale for “effective balance-sheet reduction,” not a mechanical formula

The Fed itself has already made clear that there is no fixed one-to-one conversion between balance-sheet reduction and interest rates. The actual effect depends on several factors:

  • What maturities of assets are being reduced;
  • The size and maturity structure of Treasury issuance;
  • Whether bank reserves are already approaching the lower bound of “ample reserves”;
  • Whether repo markets and short-term funding markets remain stable;
  • How much additional duration risk the market is willing to absorb.

Second, the Fed’s balance sheet is still quite large

According to the April 23, 2026 H.4.1 data, the Fed’s total assets were about $6.65 trillion, of which outright securities were about $6.41 trillion. This means the Fed still has a fairly large balance sheet, but it also means that if the Fed wants to use balance-sheet reduction to offset rate cuts on a large scale, the market’s ability to absorb additional Treasury supply and duration risk becomes very important.

Third, if Trump wants 100bp or more, it would be difficult to fully offset that with balance-sheet reduction alone

If the Fed only delivers 25bp to 50bp of limited rate cuts, combined with a moderate degree of balance-sheet reduction, this combination still has some political and market feasibility. But if the Fed were to deliver 100bp or more in cuts and then try to fully offset that through balance-sheet reduction alone, the required scale would already be in the trillions of dollars. That would be too large, too slow, and too likely to run into liquidity and market-functioning constraints.

So in the real world, the most likely outcome is not “large rate cuts + full offset,” but rather: limited rate cuts + partial offset.

5. If balance-sheet reduction drains liquidity, where can the missing liquidity come from?

If Warsh adopts a more aggressive balance-sheet reduction strategy, the real question the market will ask is not “how much were rates cut,” but rather: where will the system make up for the liquidity that has been drained?

The answer is that the liquidity tightening caused by balance-sheet reduction does not mean the market can only passively absorb the pressure. Under the current framework, there are still several channels that can supplement or ease liquidity and reduce pressure in short-term funding markets.

5.1. A decline in ON RRP can release short-term funding

The Fed’s overnight reverse repo facility, or ON RRP, is itself a pool that absorbs market liquidity. When ON RRP balances decline, the cash held by money market funds can flow back into Treasury bills, the banking system, or the repo market, thereby reducing the direct pressure that balance-sheet reduction places on reserves.

In other words, if ON RRP still has room to decline, balance-sheet reduction may not drain bank reserves one-for-one.

5.2. A decline in the Treasury General Account (TGA) can temporarily release reserves

The U.S. Treasury’s cash account at the Fed, known as the Treasury General Account, or TGA, has a direct impact on bank reserves.

  • When the TGA rises: it usually drains reserves
  • When the TGA falls: it usually releases reserves back into the system

Therefore, if the Treasury’s cash balance falls from a high level, it can provide some buffer against the liquidity tightening caused by balance-sheet reduction. This is not a long-term solution, but the timing matters.

5.3. The Standing Repo Facility (SRP) can provide short-term liquidity

If balance-sheet reduction causes repo markets or overnight funding markets to become suddenly too tight, the Fed can use the Standing Repo Facility to provide liquidity to eligible counterparties and prevent short-term funding markets from becoming disorderly.

This is not the same as reversing balance-sheet reduction. It is a backstop. Put simply, the SRP is a fuse, not a long-term water pipe.

5.4. The Fed can adjust the pace of balance-sheet reduction

If the market cannot absorb the additional duration risk, or if reserves fall too quickly toward the lower bound of “ample,” the Fed can:

  • Slow the pace at which holdings run off naturally;
  • Adjust reinvestment arrangements;
  • Pause part of the balance-sheet reduction process.

So balance-sheet reduction is not simply on or off. It is a tool whose pace can be adjusted according to the market’s capacity to absorb it.

6. What this policy mix means for AI capex?

This is another question that is often treated intuitively, but is actually more complicated institutionally.

If interest rates fall, Treasury’s interest burden would theoretically decline because:

  • Newly issued Treasuries would carry lower coupon rates;
  • Maturing debt could be refinanced at lower cost;
  • Treasury bills and short-term debt respond more quickly to a decline in policy rates.

But this does not mean Treasury immediately “saves a sum of money” that can then be directly allocated to support AI. The interest savings from rate cuts appear gradually as fiscal space. They are not an immediately available pool of cash.

More importantly, Treasury itself does not have the authority to unilaterally allocate “interest savings” to the AI industry. Institutionally:

  • Congress decides appropriations and tax legislation;
  • The White House sets policy direction;
  • Treasury is mainly responsible for financing, cash management, debt issuance, and execution.

Therefore, the more accurate way to put it is:

If rate cuts reduce Treasury’s future debt-interest burden, that would indirectly create fiscal space; but whether that space can be turned into targeted support for AI depends on whether the White House and Congress are willing to implement it through tax, energy, permitting, and industrial policy.

If the government truly wants to preserve AI buildout, current public policy direction suggests that the more likely tools include the following:

6.1. Semiconductor investment incentives

Section 48D Advanced Manufacturing Investment Credit currently provides a 25% tax credit for investment in semiconductors and semiconductor equipment. If the government treats AI as a strategic priority, this kind of tool, which directly improves the return on capital expenditure, is more practical than simply cutting another 25bp.

6.2. Faster permitting for data centers, transmission, and power infrastructure

The White House’s July 2025 executive order has already brought AI data centers, transmission facilities, substations, natural gas generation units, and nuclear equipment into the scope of accelerated federal permitting. If Warsh adopts “partial rate cuts + balance-sheet offset,” what truly helps AI may not be cheaper capital, but shorter construction timelines.

6.3. Large-load interconnection reform

The Department of Energy has also proposed reforms around large loads, including AI data centers connecting to the grid. If AI’s bottleneck is power and grid access, rather than only the price of capital, then supply-side measures may matter even more than another 25bp cut.

In other words, if the Fed is unwilling to directly support AI through ultra-loose monetary policy, the U.S. can still use tax incentives, energy policy, and faster permitting to provide targeted support for AI capital formation.

7. The Real tail risk: Could Warsh move the nominal PCE inflation target from 2% toward 2.25% or 2.5%?

If “partial rate cuts + balance-sheet offset” is the most likely base case, then the tail scenario most worth discussing is not pure rate cuts or pure balance-sheet reduction, but this:

Whether Warsh would ultimately rewrite the Fed’s nominal PCE inflation target.

This deserves to stand on its own because it is not just an adjustment of policy tools, but a shift in the institutional language itself. Even a modest widening of the effective inflation tolerance range would already affect markets, the policy framework, and asset pricing. What the market really cares about is not the size of the immediate impact, but whether Warsh might use the language of “recalibration” to gradually turn the long-standing 2% anchor into something more flexible, something that can be redefined.

He could first build a narrative, observe how markets react, and only then decide whether to formally move the nominal PCE target from 2% to 2.25%, or even 2.5%.

If Warsh were to push in this direction, he could construct a narrative that appears defensible on the surface. For example:

  • Over the past 20 years, U.S. CPI inflation has averaged around 2.57%
  • The Fed formally anchors PCE inflation, which typically runs below CPI
  • If AI genuinely raises productivity, improves supply capacity, and lowers certain non-energy and non-housing costs, then a somewhat higher PCE operating range does not necessarily imply a loss of control, and could instead be framed as a recalibration more consistent with the real structure of the economy
  • Under this logic, allowing markets to gradually accept PCE running in the 2.25%–2.5% range, and only later formalizing a new target of 2.25% or 2.5%, would create a gradual rather than abrupt institutional shift

In other words, the key is not “changing the target overnight,” but a process:

First, build a narrative based on higher long-run CPI averages, AI-driven productivity gains, and evolving supply-side conditions; then gradually raise market tolerance for PCE running around 2.25%–2.5%; and only then, depending on market reaction, decide whether to formally adjust the nominal PCE target from 2% to 2.25% or 2.5%.

From an operational perspective, this gradual approach carries several clear incentives for Warsh:

  • It frames the shift as “recognizing reality” rather than “abandoning discipline”
  • It allows him to test how the bond market, the dollar, long-term rates, and risk assets respond to a higher inflation tolerance
  • It preserves flexibility; if the market reaction is benign, he can push the narrative further; if the reaction is sharp, he can step back and emphasize that he was only pointing out that CPI has long averaged above 2%
  • If the market begins to accept it, it effectively gives him more room on the policy side to support growth, capital formation, and AI investment expansion

More importantly, the real significance of this shift is not just that the Fed gains flexibility, but that the 2% rule, long treated as a near-fixed norm, begins to move. The market’s concern is whether the Fed still treats 2% as a hard anchor, or whether it is becoming a more adjustable framework.

If a mature economy like the U.S., especially one re-entering a phase of faster growth, higher investment demand, and accelerated technological transformation, begins to tolerate inflation modestly above 2%, then the global standard around the 2% inflation target may also begin to loosen. This does not mean higher inflation is necessarily justified; it means markets may start to reprice the Fed’s reaction function and policy boundaries.

But the difficulty of this path is equally clear. Once Warsh starts leaning toward a 2.25% to 2.5% tolerance range, the market will quickly ask:

Is this a tactical test, or the prelude to a formal change in the inflation target?

In practice, he would likely need to adjust the pace based on market reaction. If the response is mild, he may continue to push the narrative toward “2.25% or even 2.5% better reflects reality.” If the reaction is sharp, for example:

  • Long-term rates rise noticeably
  • The dollar weakens
  • Term premia expand
  • The bond market interprets this as a loosening of inflation discipline

then he may stop at the stage of “building the narrative and testing tolerance,” without rushing to formally change the target, and could even pull the discussion back from 2.5% to 2.25%.

So the real point of this tail scenario is not whether it is the base case, but how, as a low-probability, high-impact regime shift, it could unfold step by step:

  1. Start with a historical anchor, such as CPI averaging around 2.57% over the past 20 years
  2. Reframe PCE running at 2.25% to 2.5% as manageable and acceptable
  3. Then, depending on market reaction, data, and political space, decide whether to formally move the nominal PCE target from 2% to 2.25% or 2.5%

If this happens, it would likely be more than a marginal policy adjustment. It could become the deepest and most controversial institutional shift of the Warsh era.

8. Three other scenarios still need to be watched

Even if we treat the increase of the nominal PCE inflation target as a separate tail scenario, three more direct policy paths still cannot be ignored.

1. A purely balance-sheet-driven path

This is the path closest to Warsh’s institutional instinct: a smaller balance sheet, lower market intervention, and a smaller role for the Fed. The advantage is that inflation expectations may be easier to stabilize and Fed independence may become clearer; the downside is that liquidity could become too tight. At a time when Treasury issuance pressure and AI capital expenditure are rising at the same time, private-sector financing costs may be pushed higher. I see this more as Warsh’s medium-term direction, rather than the strongest move he would make immediately upon taking office.

2. A purely rate-cut-driven path

This is the market’s favorite and the most comfortable scenario in the short term. Corporate refinancing pressure would fall, and risk assets, technology stocks, and AI-related names would all benefit. But if the market believes this is driven by the political calendar rather than by data, the cost would be higher inflation expectations, long-term rates that may not fall in parallel, and damaged institutional credibility. This path is the sweetest in the short term, but the riskiest in the long term.

3. Holding steady

Warsh could also choose to basically hold steady before the midterm elections and preserve optionality. The advantage of this path is that he avoids being seen immediately as either deliberately tightening or simply accommodating rate-cut pressure; the disadvantage is that the economy and markets would receive little directional guidance. This is a strategy of first stabilizing his position, then waiting for conditions to become clearer.

Conclusion: Warsh’s policy mix would be built around compromise

If we only ask whether Warsh will be more hawkish than Powell, the framing is too crude. If we only ask whether he will accommodate Trump, the answer is too simple.

A more realistic way to put it is this: Warsh is most likely to deliver a compromise that allows Trump to claim victory, allows the market to reluctantly accept the shift, and allows Warsh himself to preserve institutional legitimacy. This is exactly what I see as the most likely base case: partial rate cuts + balance-sheet offset.

This path works because it addresses three constraints at the same time:

  • Political constraint: Trump is unlikely to nominate someone who completely ignores his preference for rate cuts.
  • Market constraint: Warsh cannot allow the bond market to see him as merely a tool for politicized rate cuts.
  • Institutional constraint: the Fed needs to preserve its inflation anchor and independence.

Under this base case, markets should keep several points in mind:

  • The Fed’s current policy rate is 3.50%–3.75%.
  • If balance-sheet reduction is used to offset rate cuts, every 25bp rate cut would roughly require around $750 billion of “effective balance-sheet reduction” to have a chance of partially offsetting it.
  • But balance-sheet reduction and interest rates do not follow a fixed formula. The actual effect depends on Treasury issuance, reserves, repo markets, and the market’s capacity to absorb it.
  • The liquidity drain can be buffered by a decline in ON RRP, changes in TGA, liquidity support through SRP, and adjustments to the pace of balance-sheet reduction.
  • If Treasury’s debt-interest burden falls because of rate cuts, that would only indirectly release fiscal space. It would not automatically become targeted funding for AI.
  • If the U.S. truly wants to preserve AI buildout, the more effective tools may be Section 48D tax incentives, faster permitting for data centers and power infrastructure, and large-load interconnection reform, rather than relying only on Fed rate cuts.
  • At a deeper level, whether Warsh first builds a narrative and then gradually moves the nominal PCE inflation target toward 2.25% or 2.5% may be more important than how much he cuts in his first move.

If Warsh sequences this precisely, his Fed will not be purely hawkish or purely dovish. It will be a Fed that places more emphasis on policy mix, sequencing, and the dual acceptability of politics and markets. If he gets the sequencing wrong, the cost will also be clear: either credibility is damaged, liquidity becomes too tight, or both happen at the same time.

References