‘Rate Cuts and QT’? Warsh Sparks Controversy, Wall Street Asks Again: Is He a Hawk or a Dove

TradingKey - Since Donald Trump announced the nomination of former Federal Reserve Governor Kevin Warsh as the next Fed Chair, market expectations for the future path of monetary policy have shifted rapidly. As a candidate known for his opposition to quantitative easing (QE), Warsh's policy leanings have garnered significant investor attention and reignited discussions about whether the Fed is turning hawkish.

On the first trading day following the announcement, the U.S. bond market experienced sharp volatility. The yield spread between 30-year and 2-year Treasuries widened to 1.35 percentage points, a nearly three-year high. Several asset management firms noted that this movement reflects the market's reassessment of Warsh's potential systemic impact on the balance sheet, interest rate policy, and even long-term borrowing costs should he become Fed Chair.

Although he is generally categorized as a "hawk," this assessment is also being questioned. The issue is: if Warsh has consistently advocated for monetary tightening, why is he favored by Trump, who has consistently pushed for easing? This seemingly contradictory signal has prompted deep exploration into his true policy inclinations.

Advocating for balance sheet reduction, but why also support rate cuts?

During his tenure as a Fed Governor from 2006 to 2011, Kevin Warsh was one of the staunchest internal opponents of excessive easing. In his view, the successive quantitative easing policies implemented by the Fed since 2008 caused its balance sheet to expand rapidly, with total holdings of Treasuries and other assets once nearing $9 trillion, severely distorting asset prices and potentially planting the seeds of inflationary risk.

Despite remaining highly vigilant about inflation, Warsh has acknowledged on several occasions that the U.S. economy currently faces pressure and that policy needs to remain appropriately accommodative. In a speech this April, he stated that the Fed "has been the primary buyer of U.S. Treasuries and other government-backed bonds since 2008," reflecting his profound judgment on the economic situation.

However, this "hawkish rate cut" stance still appears contradictory to outsiders. For instance, Warsh supports lowering interest rates during an economic slowdown while simultaneously emphasizing a significant reduction in the size of the balance sheet; historically, these two objectives can cancel each other out.

Regarding this, Mark Dowding, Head of Active Fixed Income at RBC BlueBay Asset Management, noted: "If you want to create space for rate cuts by shrinking the balance sheet, it actually does nothing to push down long-term rates or improve mortgage affordability." Yet, that is precisely the outcome Trump most desires.

Bill Campbell, a portfolio manager at DoubleLine, also warned that against a backdrop of persistently high inflation and increasing fiscal deficit pressure, Warsh might face inherent policy conflicts if he emphasizes both balance sheet reduction and rate cuts. He said: "You can't simultaneously pursue balance sheet reduction and rate cuts unless fiscal policy is controlled and inflation falls significantly. I believe Warsh himself understands this."

So, why does Warsh always seem to carry a "self-contradictory" label?

One explanation is that he must respond to Trump's political demand for "rate cuts to stimulate growth" while maintaining his fundamental views on Fed discipline and balance sheet risks. Behind this dual stance is his attempt to integrate them with a new policy narrative. For example, he emphasizes that AI is driving the U.S. into a productivity boom, which would result in a new environment of low inflation and high growth; this provides a rationale for rate cuts while leaving room for the normalization of monetary policy.

He also views the relaxation of U.S. regulatory policies as a mitigating factor for external inflationary risks, thereby further strengthening the feasibility of his policy framework.

A "Hawkish" pivot?

During the early days of Kevin Warsh's tenure as a Fed Governor, the United States was experiencing the most severe financial crisis since the Great Depression. However, his assessment of the situation at the time was widely questioned. Faced with rising mortgage defaults and a wave of unemployment, Warsh continued to emphasize the risk of inflationary pressure and advocated for maintaining high policy rates, even as the economy showed signs of deflation or even localized collapse.

Facts proved that his concerns did not materialize. Even as Fed interest rates were rapidly lowered to near zero thereafter, inflation remained low for years. In 2011, he also expressed reservations about the Fed's decision to purchase $600 billion in Treasuries, only changing his stance after repeated persuasion by then-Chairman Ben Bernanke.

This experience earned him the label of a "hardline hawk," which was a key reason why Trump ultimately did not choose him when first considering candidates for Fed Chair in 2017.

But as time passes, everything changes. Over the past few months, a series of signals has suggested a subtle shift in Warsh's monetary stance.

In an interview last July, he stated bluntly that the Fed's refusal to implement rate cuts at that time was a "major blunder" and publicly expressed support for Trump's pressure on the Fed. He also noted that today's central bank is completely different from the one he joined in 2006, even claiming that the Fed has made the "biggest macro policy mistake in 45 years" over the past few years and bears responsibility for the country's division.

These remarks were widely interpreted as a signal of him "making overtures" to Trump, reflecting that his monetary policy attitude is no longer consistently hawkish.

In November of the same year, Warsh wrote an article in The Wall Street Journal proposing a key point: the rapid application of AI will significantly boost productivity, thereby curbing inflation and creating space for future economic growth that does not rely on tightening policies. He believes AI will become a new deflationary driver, boosting competitiveness and strengthening the U.S. economy.

This logic aligns closely with the "tech-driven growth, manageable inflationary pressure" perception formed by the Trump team in recent years. Warsh is betting that AI-driven productivity gains will pave the way for a balanced path of "rate cuts + growth," providing a rational basis for a policy shift while catering to current political expectations for easing.

The Senate is about to begin hearing proceedings for Warsh's nomination, where his testimony is expected to provide the market with clearer signals regarding his policy stance.

Invesco ( IVZ) Chief Global Market Strategist Brian Levitt stated that Warsh's remarks at the hearing will be a key observation window for the market, helping investors understand the differences in style and approach between him and current Chair Jerome Powell. He noted: "We don't expect Warsh to be as hardline as perceived, nor perhaps even as hawkish as his earlier words and actions suggested."

Wells Fargo ( WFC) Investment Institute, on the other hand, believes that if Warsh is successfully appointed, he will emphasize the normalization of the Fed's balance sheet (i.e., quantitative tightening) rather than focusing on short-term rate cuts. The institution specifically pointed out that this policy focus could lead to closer coordination between the Fed and the Treasury Department.

Meanwhile, Warsh's mentor, veteran investor Stanley Druckenmiller, has also publicly defended his stance. He believes it is inaccurate to broadly categorize Warsh as a "perpetual hawk." "I've seen him show flexibility in policymaking," he said. He added that while Warsh was extremely alert to inflation around 2008, he later actively supported rate cuts during the peak of the financial crisis and advocated for easing at the start of the COVID-19 pandemic.

In 2018, the two co-authored an article opposing further interest rate hikes by the Fed, although the decision to hike was ultimately adopted only to be forced into a reversal shortly after "because the market couldn't take it."

He further pointed out that one of Warsh's greatest challenges now will be finding the appropriate policy balance between AI-driven economic growth and maintaining low inflation. As a researcher at Stanford University, Warsh maintains close ties with Silicon Valley and is adept at assessing the potential of emerging technologies and their macro risks.

"I can't think of anyone better suited for the position," Druckenmiller said of Warsh, a partner at his family office, Duquesne Capital.

How will the future path of Fed monetary policy evolve?

Despite the Fed welcoming a new Chair, monetary policy is likely to maintain its current direction in the short term.

Morgan Stanley ( MS) Chief Global Economist Seth Carpenter pointed out that while Powell's term is nearing its end and the possibility of Warsh as his successor is rising, the overall policy reaction function will not "undergo a substantive change immediately." Specifically, at the most recent FOMC meeting, despite two dissenting votes in favor of a rate cut, the meeting ultimately decided to hold steady, reflecting a lack of clear consensus within the committee.

Although Warsh has explicitly proposed the necessity of shrinking the Fed's balance sheet, mainstream views, including those of Morgan Stanley, suggest that for such measures to be implemented, sufficient support must first be established within the FOMC, pushing the timeline back to at least after next year. Even with a change in leadership, the Fed's collective decision-making model ensures it will not easily deviate from its set path.

According to Morgan Stanley's current base case forecast, the Fed may implement two rate cuts in the second half of 2026, provided that inflation slows due to tariff pressures and core price growth retreats significantly. If economic data fails to meet these two conditions—such as a further decline in the unemployment rate, robust household consumption, and a resurgence in inflation—then monetary policy may remain on hold through the end of the year.