Powell and Warsh: two central bankers, two approaches

The Fed is facing its most significant change in leadership in decades. With Warsh comes not just a different person, but a different understanding of what a central bank should do. Kevin Warsh – a former member of the Fed’s Board of Governors and a close confidant of President Trump – succeeded Jerome Powell as Fed Chair in May. What at first glance appears to be a change of personnel is in reality a paradigm shift: Warsh stands for a fundamentally different conception of how monetary policy should function.

Interest Rates and Balance Sheet: A New Package

The first and most important distinguishing feature concerns the relationship between interest rate policy and balance sheet policy. Powell analytically separated interest rate and balance sheet policy: cuts at the short end, continued QT at the long end. (QT = Quantitative Tightening: the Fed shrinks its balance sheet by not replacing maturing bonds, thereby withdrawing liquidity from the market.) Warsh reverses this approach. His programme is to cut interest rates and shrink the balance sheet as a package. In the opinion section of the Wall Street Journal in November 2025, he put it this way: “The Fed’s bloated balance sheet can be significantly reduced. This generosity can be redistributed in the form of lower interest rates to support households and small and medium-sized enterprises.” He followed this up on CNBC in July: “If the printing press could be silenced, we would have lower key interest rates.”

A Different Theory of Inflation

Linked to this is a second, fundamental difference: the diagnosis of inflation. The diagnosis of inflation is also shifting. Powell followed the classic Phillips curve model: too much growth, wages too high. (The Phillips curve describes the classic assumption that low unemployment leads to rising wages and thus to inflation.) Warsh turns this on its head: “Inflation arises when the state spends too much and prints too much.” He views AI as a disinflationary shock, as a force that tends to depress rather than drive up prices: Q3 2025 productivity at 4.9% annualised, compared to the 50-year average of 1.9%, supports his thesis, at least in part.

New Treasury-Fed Accord

Alongside monetary policy, Warsh is pursuing a second, institutional programme – and this is at least as far-reaching: a new Treasury-Fed agreement modelled on the 1951 agreement. (The 1951 agreement ended a period in which the Fed was obliged to buy government bonds at fixed prices to keep war debts affordable – it restored the central bank’s independence.) Warsh on CNBC in July 2025: “We need a new Treasury-Fed agreement, like the one we had in 1951 following another phase in which we had built up our country’s debt and were left with a central bank that was working against the interests of the Treasury.” This is not a technical detail. Such an agreement would alter the Treasury’s issuance structure (i.e. change which maturities of government bonds are newly issued) and could drastically reduce supply at the long end – by shifting new issues to the short end, by exercising restraint in issuing long maturities, and by coordinating control over what the market is actually allowed to buy.

Implications for Markets and Investors

What does all this mean for investors and markets? For the markets, this results in an unusual scenario. At first glance, a smaller balance sheet plus lower short-term interest rates would suggest a bear steepener, that is: short-term interest rates fall, long-term rates rise, the yield curve steepens and shifts in a direction that is detrimental to bond investors. However, if supply at the long end is simultaneously reduced massively, the picture changes: artificial scarcity at the long end (i.e. for bonds with long remaining maturities) meets structural demand, and long-term yields can fall despite expansionary monetary policy. It is precisely this constellation that justifies a constructive positioning in long duration, that is, a ‘ ’ exposure to long-term bonds, whose value rises when long-term yields fall, not in spite of, but because of Warsh’s programme.

Two Conditions, Two Risks

The scenario is plausible, but depends on two conditions: and both are uncertain. Whether it comes to pass depends less on his monetary policy programme than on whether the market believes his new inflation model and whether the Treasury-Fed agreement remains politically enforceable. Anyone who underestimates these two hurdles underestimates the risk of the entire thesis.

This text has been translated by AI. The German version is authoritative.