In my May 6, 2025 column titled "Trump vs. Powell: US economy is 'too big to fail'" I argued that the post-Powell era would not merely represent a change of names, but would inevitably reopen the debate over the Federal Reserve’s institutional direction. At the time, Kevin Warsh’s name was circulating largely as speculation, yet in reality, he was one of the clearest figures embodying Washington’s search for a new monetary policy trajectory. For that reason, Warsh was the candidate I deliberately chose to highlight.

Although Warsh is often regarded as a traditionally hawkish central banker, his emphasis on financial market flexibility and growth-supportive policies positioned him in closer alignment with the economic instincts of the Trump era. Indeed, the fact that Trump seriously considered Warsh before ultimately selecting Jerome Powell in 2017 demonstrated that this relationship was never a passing rumor, but rather one rooted in a deeper political-economic foundation.

What stood out most over the past year was that Warsh approached Trump not only with the promise of a more "accommodating and loyal” monetary stance, but also with a message of institutional continuity. By repeatedly stressing the importance of Powell completing his term, and by warning of the legal and economic risks of an early dismissal, Warsh appeared to prioritize the stability of the system over personal loyalty to Trump.

Following Friday’s announcement of Warsh as Trump's nominee to become the next chair of the Federal Reserve, the market reaction, including heightened volatility and a notable decline in gold and silver prices, has offered the most immediate indication of investor confidence in Warsh, at least in the short term.

Yet Trump’s remark that "someone who won’t do what I say can never be chair” suggests that Warsh’s appointment does not necessarily imply an absence of tension ahead.

For this reason, examining Warsh’s policy commitments through a technical lens, alongside the realities of market expectations, will be essential in anticipating the evolving dialogue between the White House and the Fed, at least until the November 2026 midterm elections.

Footnote to rate cuts

The market’s first instinct was to assume that Warsh would behave like a conventional hawk. Yet this is not quite his central claim. Warsh is not closing the door on rate cuts. On the contrary, he argues that rate reductions may still be possible precisely because monetary policy should not be framed solely through the policy rate, but through the Federal Reserve’s entire toolkit. In other words, the question is not simply "rates or tightness.” Rates may come down, Warsh suggests, while discipline can be maintained through other channels.

This is where the balance sheet enters the stage. Warsh contends that the Fed’s pandemic-era expansion, once an extraordinary crisis response, has now become a source of lasting distortion in the economy. Following the COVID-19 shock, the Fed initially purchased Treasury and mortgage-backed securities to stabilize traumatized markets. Those interventions gradually evolved into a form of stimulus. As a result, the Fed’s balance sheet peaked at nearly $9 trillion in the summer of 2022. This was not merely a number, but a reflection of how deeply the central bank had embedded itself into the financial system.

Warsh’s argument is straightforward: if this "bloated” balance sheet can be reduced, the space created could be redeployed in the form of lower interest rates to support households and small businesses. In theory, it is an appealing scene: a smaller Fed, lower borrowing costs, and a more efficient economy. Yet the stage becomes heavier here, because the balance sheet is no longer just a relic of past crises. It has become a standard instrument of modern monetary policy.

Through quantitative tightening, Fed holdings declined to roughly $6.6 trillion by late 2025. But in December, the central bank resumed technical purchases once again. The reason is simple: the system has grown accustomed to an "ample reserves” regime. Banks demand high levels of liquidity, and money markets operate on the assumption that such reserves will remain abundant. Analysts underline a critical threshold: when reserves fall toward the $3 trillion range, volatility begins to creep into money market rates, undermining the Fed’s ability to control its interest-rate target.

This is why Warsh’s promise to shrink the balance sheet is not merely a question of willpower, but of market tolerance. Moreover, reducing holdings mechanically tightens financial conditions. Warsh is effectively suggesting that the Fed could both cut rates and contract its balance sheet while still supporting the economy, but executing such a strategy would require extremely delicate engineering. Even a small miscalculation could trigger market disruption.

On Trump’s side, the stage is even more complex. The issue is no longer confined to the policy rate. Long-term borrowing costs, mortgage rates, and the voters’ "affordability crisis” are now central. As the November 2026 midterm elections approach, this crisis is not a minor detail hidden between acts, but part of the main set itself. Yet the Fed’s control over long-term yields is limited. Powell cut rates last year, but the 10-year Treasury yield climbed higher, as markets continued to price inflation expectations and fiscal risks.

Warsh and Treasury Secretary Scott Bessent are placing their biggest bet on an AI-driven productivity boom: If productivity accelerates, inflation could ease and long-term rates may eventually soften. But this remains a scenario written for the future, not a certainty anchored in the present.

Therefore, the first act of this story is not over. In fact, it is only about to start. Warsh has stepped onto the stage, and markets have offered their initial applause. But under Trump’s shadow, no leading actor performs without tension. The real conflict of this play will unfold along the fragile line between rates and the balance sheet, and within the political calendar leading to 2026.