Trump nominated Kevin Walsh as Fed chairman, gold plummeted 8.35%, the biggest drop in 40 years, and the U.S. dollar index rose more than 1%. Walsh advocates a contradictory combination of “interest rate cuts and balance sheet reduction”, believing that AI is a deflationary force and refuses to be a big buyer of U.S. bonds. Nomura and Barclays have serious differences in their position on their eagle pigeons.
Interest rate cut plus contraction table: Pump water while releasing water
Kevin Walsh’s nomination was widely regarded by the market as “exceeding expectations” because the previous favorites were purely dovish figures, and their policy proposals focused more on aggressive interest rate cuts to cater to Trump’s political demands. Although Walsh also supports interest rate cuts, he is also a staunch “critic of excessive quantitative easing (QE)” and has long advocated reducing the Fed’s huge balance sheet.
Interest rate cuts, as a core means of easing monetary policy, aim to reduce borrowing costs and inject liquidity into the market to stimulate economic activity. Balance sheet reduction (quantitative tightening, QT) aims to recover market liquidity by reducing the central bank’s asset holdings, raise long-term interest rates, and cool down the overheated economy. Kevin Walsh’s core proposition is to implement a policy combination of “interest rate cuts + balance sheet reduction”, which is tantamount to asking the Fed to “pump water while releasing water”.
Mark Dowding, chief investment officer of Royal Bank of Canada BlueBay Asset Management, analyzed, “From the perspective of traditional monetary policy frameworks, it is indeed contradictory to cut interest rates while shrinking the balance sheet. But Walsh himself did not understand it that way. He has long believed that the size of the Fed’s balance sheet is too large and must be contracted.” He believes that under this logic, if you want to promote balance sheet reduction without significantly tightening financial conditions, you need to avoid risks through lower Fed interest rates.
The contradiction of the combination of “interest rate cut and balance sheet reduction”
Interest rate cut target: Reduce borrowing costs and inject liquidity
Balance sheet reduction target: Recover liquidity and raise long-term interest rates
Historical conventions: Balance sheet reduction is usually accompanied by interest rate hikes rather than interest rate cuts
Wash Logic: Use low interest rates to hedge the tightening effect of balance sheet reduction
Market concerns: Policy signals are confusing and difficult to predict the effect
The two balance sheet reduction cycles in the history of the Federal Reserve show that balance sheet reduction and interest rate hikes are the “standard”, and interest rate cuts have never been tied to continuous balance sheet reduction for a long time. In October 2017, the Fed launched its first balance sheet reduction cycle, and for most of 2017 and 2018, it was accompanied by sustained interest rate hikes. It was not until July 2019 that the first rate cut began, and at the time of this cut, the Fed had clearly announced that the balance sheet reduction plan was coming to an end.
The second balance sheet reduction cycle began in June 2022, when the Fed’s assets were close to $9 trillion, accounting for more than 30% of US GDP. To curb inflation, the Fed has adopted a strong tightening combination of significant interest rate hikes and rapid balance sheet reduction (up to about $950 billion per month). It was not until September 2024 that the rate cut cycle began.
The AI revolution is the theoretical backbone of rate cuts
The cornerstone of Kevin Walsh’s logic is the “productivity revolution” that is taking place. In an opinion piece in November 2025, Walsh pointed out that the Fed “should abandon the dogma that too fast economic growth and high wages for workers will cause inflation.” He believes that technologies such as AI will drive productivity levels and ease inflationary pressures.
Walsh wrote: “AI will be a significant deflationary force that will not only improve production efficiency, but also enhance the competitiveness of the United States.” In Walsh’s view, since productivity has been revolutionized, the goal of cutting interest rates is no longer to stimulate aggregate demand, but to adapt to supply-side expansion and provide lower-cost funds for the real economy.
This logic of “cutting interest rates for the supply side” is cleverly in line with Trump’s political appeal to lower interest rates to stimulate economic growth, and also explains why he has been historically hawkish but currently supports interest rate cuts. Mark Dowding believes that the productivity gains brought about by AI proposed by Walsh will reduce inflation levels in the medium to long term and will also provide additional theoretical support for his low interest rate policy.
However, there are significant uncertainties in this theoretical basis. Can AI’s productivity boost really offset the inflationary pressures caused by interest rate cuts? There is currently no answer to this question. Never before has AI been applied on such a large scale in history, and its impact on the economy is an unprecedented experiment. If AI’s deflationary effects are not as expected, Kevin Walsh’s policy framework could quickly collapse.
Investment banks are seriously divided: hawkish or dovish?
Will Kevin Walsh be the driving force behind loose monetary policy, or will he return to his tightening nature? Nomura and Barclays Bank two major institutional analysts gave diametrically opposite interpretations.
David Seif, chief economist at Nomura Developed Markets, believes that Walsh will take a dovish stance in the short term after becoming Fed chairman. Since Trump’s victory, Walsh has clearly shifted to advocating for loose monetary policy. This change is directly related to Trump’s nomination demands: Trump has always listed “willingness to cut interest rates” as a core condition throughout the selection process for the Federal Reserve chairman.
Despite Walsh’s hawkish remarks in the past, David Seif believes he will not make shrinking his focus on his work. This is because excessive tightening of the financing environment in the market is likely to lead to a deterioration in the overall financial environment, a decline in the stock market, and a push up on the comprehensive borrowing costs of the private sector. This is contrary to the policy goals of Trump and U.S. Treasury Secretary Besant to lower mortgage rates and boost domestic investment. Based on this, Nomura maintains his judgment that under Walsh’s leadership, the Federal Reserve will cut interest rates once each in June and September this year.
Barclays analyst Marc Giannoni has the opposite view, making it clear that “Walsh is still hawkish in nature.” Unlike other popular candidates who have explicitly called for a significant rate cut, Kevin Walsh’s statement on interest rate cuts is extremely limited, only publicly calling for a rate cut when the FOMC decided to keep interest rates unchanged in July last year, and the rest of the relevant statements are “contextually appropriate and with limited conditions.”
In addition, Walsh has always advocated that AI is an “important deflationary force” that drives productivity improvement, which has become the core basis for stabilizing the economy without relying on aggressive easing, and is far from Trump’s proposal for rapid interest rate cuts. At the same time, Walsh is well aware of the importance of monetary policy independence - in 2010 he gave a speech titled “Ode to Independence”, making it clear that monetary policy should be independent of political pressure, which is an important feature of hawkish stances.
Refusing to be a big buyer of U.S. bonds will impact global liquidity
Kevin Walsh argues that the core impact of balance sheet reduction will be directly aimed at the “lifeline” of the US bond market: once the Fed shrinks its balance sheet, it means that the “largest buyer” holding a huge amount of US bonds will leave the market and throw a large amount of bonds into the market. However, recent market data shows that the ability of U.S. bonds to “take over”, especially demand from overseas, is already quite fragile.
In the 2025 U.S. Treasury bond auction, the ratio of “indirect bidders”, the core indicator of overseas demand, fell to 59.3%, a new low in nearly four years, and primary dealers were forced to cover 15.3%, the highest record in more than a year. In the five-year U.S. Treasury auction in July, the overseas subscription ratio slipped to 58.3%, the lowest in three years; The 30-year U.S. Treasury auction in August was even more miserable, with the proportion of primary dealers taking on the loan soaring to 17.46%, the highest in nearly a year.
This series of weak auction data shows that the enthusiasm of overseas investors, including central banks around the world, for U.S. bonds has continued to cool. If the Fed, the largest buyer, withdraws, who will take over? The market is concerned that US bond yields may rise sharply, pushing up mortgage interest rates and corporate medium- and long-term financing costs.
If Kevin Wash resumes balance sheet reduction, it will widen the gap between supply and demand of U.S. bonds, force the maturity premium of U.S. bonds to rise, and push up mortgage interest rates and medium- and long-term financing costs of companies; Short-term U.S. bonds are supported by expectations of interest rate cuts, and the impact on yields is limited.
For the US dollar, there will be phased support in the short term, as the market temporarily regards Walsh’s proposal for balance sheet reduction as a signal to “defend the dollar’s credit”. However, the US dollar is expected to be difficult to change its weakness in the medium and long term, on the one hand, the US fiscal deficit is high, and on the other hand, the marginal trend of global “de-dollarization” remains unchanged.
Analysts at Industrial Securities believe that in the long run, the credit of the US dollar is still easy to go down and difficult to rise. Trump’s approach of undermining the global order and seeking the dollar and the Fed’s policy to change according to his will will still damage the dollar’s credit and lead to the deterioration of sovereign credit. The decline in the attractiveness of the US dollar and the rise in the value of gold allocation remain certain.
Kevin Walsh faces internal FOMC resistance
Kevin Walsh’s reform blueprint must also face resistance from within the Fed. Although the Fed chairman has control over agenda setting and external communication, he still needs to follow the FOMC’s collective voting process when making decisions on core monetary policy.
First, Walsh will face a FOMC with disagreed opinions and a potentially tougher overall stance than he anticipated. According to the regulations, the adjustment of monetary policy such as interest rates follows the principle of a majority vote of 12 voting committees. Judging from the composition of this FOMC, there is significant resistance to pushing for additional significant interest rate cuts. Of the four local Fed presidents who will receive voting rights in 2026, three are clearly hawkish and one is neutral and dovish.
Secondly, on balance sheet policy, Kevin Walsh will challenge the clear and consistent collective consensus that the FOMC has formed. The FOMC has decided to officially end the QT that began in 2022 on December 1, 2025, and launch the “Reserve Management Purchase (RMP) Program”, which focuses on the purchase of short-term Treasury bonds.
More importantly, the Fed’s research article “The Triple Dilemma of Central Bank Balance Sheets” just released in January 2026 pointed out that central banks face an “impossible triangle” when setting the size of their balance sheets, and they must make trade-offs in practice. The current launch of the RMP program to maintain a larger balance sheet is essentially a priority for the Fed to ensure the stability of short-term interest rates and reduce intervention in day-to-day open market operations. Kevin Walsh’s return to the “scarce reserve mechanism” of small-scale balance sheets directly challenges this theoretical framework.
Regarding the relationship between Trump and Kevin Walsh, the market believes that there is a high probability that the two will have a honeymoon period, but the possibility of a conflict in the medium to long term cannot be ruled out. The honeymoon period is formed due to the alignment of short-term goals, but when inflation rebounds or the dollar depreciates excessively, Walsh may choose to slow down interest rate cuts, which will cause dissatisfaction in the White House. Historical experience shows that the Fed chairman often shows policy independence based on institutional interests after taking office, and pressure from the White House in this process often leads to conflicts between the two sides.
