GF Securities: Wosh Era Outlook - Three Shifts in the Federal Reserve's Policy Framework

Summary

First, on January 30, 2026, Trump announced that he would nominate Warsh to serve as the next Federal Reserve Chair, succeeding Powell, whose term as Chair will expire in May. In his statement, Trump reviewed Warsh’s professional background and claimed that Warsh would become “one of the greatest Fed Chairs in history” (he will go down as one of the great Fed chairmen), and that “he will never let you down” (he will never let you down). The nomination still requires hearings before the Senate Banking Committee and confirmation by the full Senate.

Second, Warsh’s background is highly diverse, combining practical experience in Wall Street mergers and acquisitions, White House economic policy work, and Federal Reserve crisis response. He served as an Executive Director at Morgan Stanley from 1995 to 2002, responsible for M&A, familiar with Wall Street operations; from 2002 to 2006, he was a Special Assistant for Economic Policy at the White House and Executive Secretary of the National Economic Council. He was a Federal Reserve Board member from 2006 to 2011. During the 2008 global financial crisis, he served as the chief liaison between the Fed and Wall Street and was a G20 delegate. In 2011, he resigned in opposition to the second round of quantitative easing (QE2), believing that large-scale bond purchases distort markets and could lead to serious inflation and lax fiscal discipline in the future. After leaving the Fed, Warsh became a senior visiting scholar at Stanford’s Hoover Institution and a partner at the Duken Family Office.

Third, regarding growth understanding, Warsh belongs to the supply-side school. He believes that the US economy’s below-potential growth is not due to insufficient aggregate demand but results from inefficient capital allocation and regulatory rigidity suppressing the supply side. He thinks the Fed’s current understanding of potential growth underestimates the resilience of the US economy and overlooks the nonlinear growth potential brought by technological change. Warsh believes the US economy is experiencing a productivity boom driven by AI. Increasing the annual labor productivity growth rate by 1 percentage point could double living standards within a generation without causing inflation.

Fourth, on inflation, Warsh sees inflation as chiefly the Fed’s responsibility (Fed is chiefly responsible), not just a passive result of external shocks—that is, inflation is a choice (inflation is a choice). He argues that during the recent high-inflation years, blaming external factors was a form of scapegoating, directly denying Powell’s logic that the 2021-2022 inflation was caused by supply chain issues and the Russia-Ukraine conflict. Warsh’s framework implies the Fed will not excuse cost-push inflation; if tariffs or supply shocks push prices higher, his reaction function is more likely to be tightening rather than waiting, contrasting sharply with Powell’s “transitory inflation” narrative.

Fifth, regarding interest rate policy, Warsh’s past public statements tend to be hawkish, but Trump has repeatedly said Warsh supports rate cuts. Based on Warsh’s academic views and recent remarks, we lean toward believing his policy stance will favor gradual rate cuts. The core logic is to reassess the Fed’s policy path through a supply-side lens, meaning rate cuts are not for demand suppression but to accommodate supply. Warsh believes the traditional Phillips curve relationship between unemployment and inflation has become ineffective, as AI-driven productivity leaps are reshaping the US economy’s potential output, allowing strong growth without necessarily triggering inflation, thus providing room for lower rates. This framework aligns closely with Trump’s policy goal of lowering financing costs.

Warsh believes the Fed should not mechanically maintain high rates due to strong economic data. He advocates that if growth is driven by productivity (especially AI infrastructure and applications), such growth is inherently disinflationary. He criticizes the current Fed models for overemphasizing demand-side pressures and neglecting supply-side expansion. Warsh argues that high wages and strong growth do not necessarily cause inflation; as long as productivity growth outpaces money supply and government spending, there is room for lower interest rates to support long-term capital expenditure cycles.

“The dogmatic belief that inflation occurs when workers earn too much should be discarded… AI would boost productivity, strengthen U.S. competitiveness, and act as a disinflationary force.”

He also criticizes the Fed’s view that high economic growth causes inflation, asserting that the root cause is government overspending and excessive money printing. The Fed’s large balance sheet, supporting major firms during crises, can be significantly reduced. In other words, he believes that easy monetary policy has not boosted the real economy but has blurred the fiscal-monetary boundary, fueling inefficient public spending and moral hazard in the private sector.

“Money on Wall Street is too easy, and credit on Main Street is too tight. The Fed’s bloated balance sheet, designed to support the biggest firms in a bygone crisis era, can be reduced significantly.”

Furthermore, Warsh sees structural barriers on the supply side—excessive regulation, capital misallocation, and central bank distortions of market signals—as the real bottleneck to growth. Pro-growth policies should also include reforming regulatory conduct to provide clearer, more timely rules, enabling firms to innovate and succeed or fail without protecting incumbents at the expense of smaller, more dynamic competitors.

He remains optimistic about technological change and productivity growth. He believes the Fed’s current estimate of potential growth is severely underestimated, especially ignoring the nonlinear growth leap that AI and general-purpose technologies could bring. In a 2025 speech at G30/IMF, Warsh explicitly stated that productivity is key to achieving inflation-free prosperity. Raising annual productivity growth by just 1 percentage point could double living standards within a generation without causing price instability.

“Productivity is the key to prosperity without inflation. If we can raise labor productivity growth by even one percentage point annually, we can double living standards in a single generation — and do so without triggering price instability.”

This implies that if the Fed continues to interpret the economy through an outdated Phillips curve framework, equating strong growth with inflation risk, it may prematurely tighten policies, stifling the endogenous growth momentum driven by productivity booms. Warsh’s framework suggests that under an AI-driven new economy paradigm, the Fed should tolerate higher real growth without fearing inflation, provided monetary discipline is restored and capital flows into genuinely productive investments rather than speculative assets driven by artificially suppressed rates.

Fifth, on inflation, Warsh views it as chiefly the Fed’s responsibility (Fed is chiefly responsible), not just a passive result of external shocks—that is, inflation is a choice (inflation is a choice). He believes that during the recent high-inflation period, blaming external factors was a form of scapegoating, directly denying Powell’s logic that supply chain issues and the Ukraine war caused the inflation of 2021-2022. Warsh’s framework implies the Fed will not excuse cost-push inflation; if tariffs or supply shocks push prices higher, his reaction function is more likely to be tightening rather than waiting, contrasting sharply with Powell’s “transitory inflation” narrative.

In a July 2025 Hoover Institution interview, Warsh mentioned that he believes Milton Friedman’s view that inflation is a choice. Congress, in its 1970s review of statutes, assigned the responsibility for price stability to the Fed, aiming for an agency accountable for prices, not blaming others. He argues that when policymakers ignore problems and blame others, inflation risks spiral out of control. When the Fed acts sluggishly or lacks resolve, inflation embeds itself into price formation.

He also notes that recent commentary does not reflect that inflation is a choice. During the past five or six years of rising inflation, what reasons did we hear? Putin in Ukraine. The pandemic and supply chains. Milton Friedman would be outraged to hear this.

“I believe what Milton Friedman and you just channeled, which is inflation is a choice… inflation and ensuring price stability was granted to the Federal Reserve by the Congress most recently in a review of its statutes in the 1970s. So that there would be one agency that would be responsible for prices. No more blaming the other guy. We’re giving the baton to you, the Central Bank.”

“Now you wouldn’t know from recent commentary of the last several years that inflation were a choice. In fact, during the run-up to the great inflation last five or six years, what did we hear about the causes of inflation? It was because of Putin in Ukraine. It was because of the pandemic and supply chains. Well, Milton would be outraged to hear that.”

We understand that Warsh’s framework implies the Fed will not excuse cost-push inflation. If tariffs or supply shocks push prices higher, his reaction function is more likely to be tightening rather than tolerating, sharply contrasting with Powell’s “transitory inflation” narrative.

Sixth, regarding interest rate policy, Warsh’s past public statements tend to be hawkish, but Trump has repeatedly said Warsh supports rate cuts. Based on Warsh’s academic views and recent remarks, we lean toward believing his policy orientation will favor gradual rate cuts. The core logic is to reassess the Fed’s policy path through a supply-side framework, meaning rate cuts are not for demand suppression but to accommodate supply. Warsh believes the traditional Phillips curve relationship between unemployment and inflation has become ineffective, as AI-driven productivity surges are reshaping the US economy’s potential output, allowing strong growth without necessarily triggering inflation, thus providing policy space for lower rates. This framework aligns closely with Trump’s policy goal of lowering financing costs.

Warsh believes the Fed should not mechanically maintain high rates just because economic data are strong. He advocates that if growth is driven by productivity (especially AI infrastructure and applications), such growth is inherently disinflationary. He criticizes current Fed models for overemphasizing demand-side pressures and neglecting supply-side expansion.

Warsh argues that high wages and strong growth do not necessarily cause inflation. As long as productivity increases faster than money supply and government spending, interest rates can be lowered to support long-term capital expenditure cycles.

“The dogmatic belief that inflation occurs when workers earn too much should be discarded… AI would boost productivity, strengthen U.S. competitiveness, and act as a disinflationary force.”

He also criticizes the Fed’s view that high economic growth causes inflation, asserting that Powell-led Fed’s misjudgment of inflation in 2021-2022 stems from trying to fine-tune demand while ignoring structural supply shocks and the core issue of government printing money.

“The Feds economic models wrongly assume that rapid economic growth threatens to elevate inflation. Instead, inflation is caused when government spends too much and prints too much.”

We understand that this means the Warsh-led Fed may no longer see GDP growth above 3% as overheating, avoiding preemptive rate hikes to curb growth. In a October 2025 interview, he also mentioned that we could significantly lower interest rates to make 30-year fixed mortgages affordable and restart the housing market. The way to do this is to release the balance sheet and withdraw money from Wall Street.

“We can lower interest rates a lot, and in so doing get 30-year fixed-rate mortgages so they’re affordable, so we can get the housing market to get going again. And the way to do that is, as you say, to free up the balance sheet, take money out of Wall Street.”

Seventh, on the relationship between monetary and fiscal policy, Warsh advocates for promoting a “New Treasury-Fed Accord.” In a previous CNBC interview, Warsh explicitly proposed restructuring the functions of the Fed and the Treasury, referencing the 1951 Treasury-Fed agreement to redefine their responsibilities. The core idea is that the Fed should focus on interest rate management, while the Treasury handles government debt and fiscal accounts, with clear separation to prevent political influence on monetary policy decisions. Regarding balance sheet management, Warsh criticizes the Fed’s ongoing balance sheet expansion during stable periods, viewing the current roughly $7 trillion size as an abnormal residual of multiple crises. He advocates accelerating balance sheet reduction and shortening asset durations to normalize monetary policy.

In a July 2025 CNBC interview, Warsh mentioned, “We need a new Treasury-Fed accord, like we did in 1951 after another period where we built up our nation’s debt and we were stuck with a central bank that was working at cross purposes with the Treasury. That’s the state of things now. So if we have a new accord, then the Fed chair and the Treasury Secretary can describe to markets plainly and with deliberation, 'This is our objective for the size of the Fed’s balance sheet’.” In a May 2025 Hoover Institution interview, he added that the Treasury Secretary should be responsible for fiscal matters, not muddled into the Fed, which would only politicize the Fed.

“We need a new Treasury-Fed accord, like we did in 1951 after another period where we built up our nation’s debt and we were stuck with a central bank that was working at cross purposes with the Treasury. That’s the state of things now. So if we have a new accord, then the Fed chair and the Treasury Secretary can describe to markets plainly and with deliberation, 'This is our objective for the size of the Fed’s balance sheet’.”

We understand that Warsh believes the Fed’s balance sheet should be used for emergencies, and when crises contact, the Fed should exit (shrink the balance sheet). However, with reserve levels now below peak, further balance sheet reduction faces liquidity constraints. Therefore, Warsh’s framework may include coordinating with the Treasury on debt issuance structures, adjusting reserve requirements, or using other tools to implement shadow shrinkage. The specific operational details remain to be confirmed.

Eighth, on market communication, Warsh has publicly criticized Powell’s era for over-transparency, believing that high-frequency, highly certain policy signals weaken market’s autonomous pricing and risk recognition. Therefore, if Warsh leads reform, the dot plot might be canceled or substantially revised, and the frequency of Fed officials’ public statements could be significantly reduced. This would reintroduce a highly uncertain policy environment with lower visibility, requiring markets to incorporate higher volatility premiums in pricing to hedge against reduced policy predictability.

In a 2016 Wall Street Journal article titled “The Federal Reserve Needs New Thinking,” Warsh stated that recent monetary policy implementation has been deeply flawed, and reform should involve more rigorous review of recent policy choices and major changes in tools, strategies, communication, and governance.

“The conduct of monetary policy in recent years has been deeply flawed… A robust reform agenda requires more rigorous review of recent policy choices and significant changes in the Fed’s tools, strategies, communications and governance.”

Ninth, in summary, Warsh’s policy philosophy could lead to three shifts in the Fed’s framework: first, from demand-side to supply-side analysis; second, from a multi-objective focus including financial stability to a core focus on price stability; third, from high transparency to lower predictability in market communication. The core idea is to use more flexible interest rate policies combined with supply-side capacity expansion to release growth momentum, while using balance sheet management to hedge potential inflation risks, forming a policy mix of wide interest rates and tight balance sheets. Two key uncertainties remain: one, whether AI can substantively boost productivity at the macro level; two, whether such productivity gains in a low-inflation environment will indeed keep inflation in check. If these do not meet expectations, markets may face rising term premiums and secondary inflation pressures.

At the policy framework level, Warsh’s appointment could bring three shifts: one, from demand management to supply-side logic, with the Fed possibly no longer viewing GDP growth above 3% as overheating; two, a return to a core focus on price stability, with functions like banking regulation and climate risk standards possibly transferred to the Treasury, emphasizing the Fed’s independence in setting interest rates and inflation targets; three, a shift from high transparency to reduced policy predictability, with dot plots possibly canceled or revised, and markets needing to incorporate higher volatility premiums.

For markets, if Warsh’s supply-side logic dominates policy, it could maintain high growth expectations while opening room for rate cuts, but this depends heavily on actual productivity improvements. His long-standing criticism of balance sheet expansion suggests that, in guiding short-term rates downward, he might adopt a more aggressive shrinkage pace, steepening the yield curve and increasing long-term rate volatility. If supply-side reforms lag, markets could face rising term premiums and secondary inflation pressures.

Gold market experienced a sharp decline on January 30. We interpret this as related to accumulated profit-taking from prior gains, institutional long positions being closed, and the overlay of algorithmic trading (CTA). From the perspective of the “Warsh Effect,” market concerns may include: (1) Warsh’s rejection of debt monetization and his advocacy for balance sheet reduction. If the Fed significantly shrinks its balance sheet in the future, it could re-boost dollar credit, breaking key support levels for precious metals (expectation of credit currency devaluation); (2) although Warsh believes new technologies can eliminate inflation, this remains a long-term narrative; he is hawkish on actual inflation issues, and markets worry that if short-term inflation spirals out of control, he might respond with resolute tightening. The unexpectedly high US PPI data released on January 30 amplified these concerns.

Risk Warning: If inflation does not decline as expected or fiscal easing leads to demand overheating, the Fed may keep high interest rates longer. Geopolitical uncertainties and potential tariff policy changes could impact supply chain recovery. If macro data deviate from the soft-landing baseline, current asset prices priced for rate cuts and soft landings may face sharp valuation corrections.