①The primary concern within the industry currently lies in the combination of Kevin Warsh's unconventional policy positions, which could lead to a tightening of financial conditions and create an environment of structurally high volatility across various asset classes.
②However, macro strategist Michael Ball pointed out that Kevin Warsh still holds a trump card: his view on the Federal Reserve's excessive intervention aligns with Treasury Secretary Bessent, creating a possibility for an informal agreement between the two institutions.
The challenge for Kevin Warsh in leading the Federal Reserve is how to reduce the Fed’s presence in financial markets without inadvertently tightening financial conditions.
Wash has repeatedly advocated for reducing the balance sheet and placing greater emphasis on inflation stability, which earned him a reputation as a hawk in history. Meanwhile, he recently expressed support for lowering borrowing costs.
The main concern within the industry currently is that this unconventional combination of policy stances may lead to tighter financial conditions and create a structurally high-volatility environment across various asset classes. The reduction in liquidity support due to the central bank's scaled-down asset holdings will increase market risk premiums. Reducing the balance sheet may also push up term premiums, thereby raising discount rates.
This will compress the value of future cash flows, thereby depressing equity valuation multiples—a dynamic that will hit loss-making or highly leveraged companies hardest, as investors discount more uncertain and distant earnings while accounting for more expensive financing costs.
However, macro strategist Michael Ball pointed out that despite the various risks associated with his policies, Wash still holds an ace: his view on the Federal Reserve's excessive intervention aligns with Treasury Secretary Bessent, creating the possibility for an informal agreement between the two institutions—ultimately benefiting risk assets.
The 'Wash-Bessent' World
Bessent has previously stated multiple times that more predictable bond issuance would suppress supply uncertainty. Combined with active repurchase plans and banking regulatory reforms, it would reduce the compensation required by investors when they worry about sudden changes in auction size and maturity mix.
In response, Ball noted that under the 'Wash-Bessent' model, the reduction of the Fed’s balance sheet can be matched with a predictable Treasury debt plan, providing the market with greater clarity on liquidity and supply.
If the Treasury’s issuance and the Fed’s balance sheet reduction path remain stable and credible over the long term, unintended tightening of financial conditions can be avoided, and any non-forced shocks in the interest rate market will be limited.
In addition, Wash's inclination to lower interest rates will create room for price increases at the front end of the yield curve.
At the same time, with the central bank reducing its balance sheet, the outlook for debt issuance is more stable, and excess liquidity is effectively controlled. Any higher term premium on long-term government bonds may be mitigated as a result, collectively reducing premium compensation.
The Impact of Reforming the Federal Reserve
Ball also pointed out that, beyond the impact on cross-asset volatility, Wash tends to reduce the Federal Reserve's influence in financial markets, meaning that the power of fiscal and regulatory reforms will be returned to government officials. This will help strengthen market discipline and restore accountability mechanisms to their pre-global financial crisis state.
Under the Federal Reserve's current interest rate floor system, the potential for regulatory reform is crucial. The fundamental limitation on balance sheet reduction lies in banks' demand for reserves. Under regulatory requirements, banks are forced to hold large amounts of reserves and government bonds as high-quality liquid assets.
Deregulation, lowering liquidity thresholds, and reducing structural demand for reserves will suppress volatility in repo transactions and free up dealers' balance sheets, enabling them to intermediate more government bond supply and matched repo trades. As financial institutions become more actively involved and are more willing to use the Federal Reserve’s liquidity tools, broader market liquidity and depth will improve, thereby supporting government bond prices.
Ball also mentioned several other policy positions held by Wash.
For example, Wash believes that the Federal Reserve's forward guidance "has little effect in normal times."
Ball noted that abandoning this practice (forward interest rate guidance) would alter investor behavior, breaking the market habit of preempting the Federal Reserve's actions, and might even encourage a fundamentals-oriented framework to reduce reliance on Federal Reserve signals.
Wash has also pointed out that long-term government bonds play a unique role.
The level and volatility of long-term government bond yields can be considered the most important price globally, influencing the valuation of virtually all assets. Ball believes that the Fed reform objectives proposed by Warsh could enhance policy credibility by reducing the size of the balance sheet. If coupled with potential coordination with Treasury policies, this would contribute to achieving more stable long-term bond yields.
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