With the new Federal Reserve Chairman's hearing imminent, will it reshape rate cut expectations?

Morning FX

Tuesday (21st),Federal Reserve Chair nominee Kevin Warsh faces his final test: Senate hearing. Previously, Trump was eager for him to take office, but due toSenator Tillis’ obstruction (on the condition that accusations against Powell be dropped), it was postponed. With the Department of Justice dropping the investigation into Powell, Warsh’s prospects of assuming the Fed chair in May are drawing closer.

Image: The wealthiest Fed chair with a net worth of $130 million

Warsh will be facing a complex situation upon taking office: on one hand, the quagmire of war is pushing oil prices higher and fueling a rebound in inflation; on the other hand, the Federal Reserve itself is divided (Governor Milan is still calling for three rate cuts this year), combined with Trump’s influence on monetary policy and a stock market characterized by heightened risk sentiment.

I. Facing a “Test of Resilience” Right Upon Taking Office

Warsh supports controlling the Fed’s balance sheet but also emphasizes the importance of forward-looking monetary policy. Before this round of oil price increases,Warsh was one of the few who supported preemptive rate cuts, which was a main reason the market was expecting greater room for rate cuts at the start of the year.

Image: March CPI sharply rebounded

However, rising oil prices drove a substantial month-on-month rebound in March’s CPI, clouding the outlook for rate cuts. At the peak of panic in March, the market even priced in a rate hike; now, just 0.4 rate cuts are expected this year.

Although Warsh is considered potentially dovish, he is likely to emulate Powell in his early days and refrain from rash moves. With Trump eagerly awaiting the man he nominated, it remains to be seen whether Warsh can show enough resilience to safeguard the Fed’s reputation for independence.

Image: Almost no hope for rate cuts this year

II. Beyond Rate Cuts, What Else Should Be Watched?

One is the Fed’s balance sheet trajectory. Since December 2025, the Fed has stopped QT and maintained the balance sheet at around$6.7 trillion by rolling over Treasuries. Warsh hopes to shrink the balance sheet to about $4 trillion; he has long criticized the current size for causing severe capital misallocation, claiming that excess liquidity is the root cause of inflation.

Image: Fed’s balance sheet

But this year, dollar liquidity has already been tight, with onshore USD interbank rates and implied swap rates remaining high. If balance sheet reduction resumes, it will hit already fragile short-term liquidity.

Secondly, persistently high long-term interest rates. The U.S. Treasury yield curve is no longer inverted but long-end yields remain elevated. Since the Fed’s rate cut in September 2024, the policy rate fell from 5.5% to 3.75%, the two-year yield dropped from 4.9% to 3.7%, yet the ten-year Treasury yield is still unchanged at a high 4.3%. High rates threaten government financing costs, leverage risks, and the stock market.

Image: Elevated long-term rates

III. Summary

(1) Warsh’s path to office is accelerating, and if his performance at the hearing is solid, he will likely officially become the new Fed chair in May.

(2) Once in office, he will face both a rebound in inflation and a test of the Fed’s independence. Should he push to shrink the balance sheet, it will also impact market liquidity.