Besant feeds "calm pills": The Federal Reserve is unlikely to shrink its balance sheet quickly, and Wosh is very independent!

Since U.S. President Trump announced the nomination of former Federal Reserve Board member Kevin Warsh as the next Federal Reserve Chair, concerns about this new chair have persisted, focusing on the Fed’s policy shift leading to liquidity tightening and potential loss of independence.

On Sunday, U.S. Treasury Secretary Yellen attempted to downplay market worries. She stated that even under the leadership of Fed nominee Kevin Warsh (who has criticized the Fed’s bond-buying activities), she does not believe the central bank will take rapid action to reduce its balance sheet.

Yellen said on a program that the Fed may need up to a year to make decisions regarding its balance sheet, and added that Warsh would be a very independent Fed chair.

“As for how the Fed plans to adjust its balance sheet, that will be up to them,” Yellen said. If they implement a ‘reserve requirement’ policy, I don’t think they will act quickly because that indeed requires a larger balance sheet. So, I think they might wait and see, at least for a year, to decide what to do.

To lower long-term interest rates, the Fed significantly expanded its balance sheet during the global financial crisis and the COVID-19 pandemic, reaching a peak of $9 trillion in summer 2022, then gradually reducing it (a process known as quantitative tightening), to $6.6 trillion by the end of 2025.

However, in December last year, the Fed restarted its balance sheet expansion, announcing plans to purchase short-term government bonds to regulate market liquidity and ensure stable control over interest rate targets.

Warsh, who served as a Fed governor from 2006 to 2011, believes that the large amount of bonds held by the Fed distorts financial conditions and advocates for significantly reducing the central bank’s bond holdings.

Former President Trump stated that he wanted mortgage rates to be significantly lowered. Experts point out that shrinking the Fed’s balance sheet conflicts with Trump’s goal of lowering interest rates, and maintaining financial stability while shrinking the balance sheet is not an easy task.

Additionally, given Warsh’s hawkish past statements, many analysts are worried that the Fed’s “rate cut path” may come to a halt.

However, Goldman Sachs noted in a report last week that the market might once again misjudge the actual stance of the new Fed chair. Warsh-led Fed may not necessarily lead to higher interest rates; rate cuts and quantitative easing are still under consideration. Goldman also believes Warsh will not push for a large reduction in the Fed’s balance sheet, as there is broad support within the Fed for the “ample reserves” framework.

Uncertainty remains about what stance Warsh will take after becoming Fed Chair, and market speculation is ongoing. Trump commented on this last Wednesday. He straightforwardly said that if his nominated Fed chair candidate has expressed a willingness to raise rates, that person will not get the job. He also stated that he has no doubt that rates “will be lowered very soon.”

Notably, the day after announcing Warsh’s nomination as the next Fed Chair, Trump joked that if Warsh does not cut rates, he might sue him.

Yellen also did not rule out the possibility of such a scenario. Last week, during a Senate Banking Committee hearing, she said that whether Warsh would ultimately be prosecuted if he failed to cut rates as President Trump wished “depends on the President.”

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(Source: Caixin)