What does Goldman Sachs think of Wash? The market always

# Source: Wall Street Insights

By Bao Yilong

Mike Cahill, Foreign Exchange Strategist at Goldman Sachs, stated that it would be a mistake to judge Kevin Warsh’s policy orientation solely based on his previous remarks, noting that *"being willing to cut interest rates is a prerequisite for him to get this job"*. David Mericle, Economist at Goldman Sachs, pointed out that he does not believe Warsh will push for a drastic reduction of the balance sheet, given the broad support within the Federal Reserve for the "ample reserves" framework. Brown, US Treasury Bond Trader at Goldman Sachs, bluntly stated that aggressive balance sheet reduction would be extremely damaging to risk assets.

Following Trump’s nomination of Warsh as the next Federal Reserve Chair, the market quickly bet on a more hawkish balance sheet policy, yet Goldman Sachs believes the market may have misjudged the situation.

As reported by Wall Street Insights, on January 30, Trump nominated former Federal Reserve Governor Kevin Warsh to serve as the next Fed Chair. After the news was announced, long-term bond yields edged up, the US dollar rebounded, and precious metals plummeted. The market appeared to be pricing in his hawkish views on the balance sheet.

Recently, however, Goldman Sachs’ trading and research teams have conducted in-depth analyses of Warsh, concluding that the market may have once again misjudged the actual stance of the incoming Fed Chair.

Mike Cahill warned against judging Warsh’s policy orientation merely by his past comments at the Fed, noting:

*We know that at the very least, being willing to cut interest rates is a prerequisite for him to land this role.*

Brown, Goldman Sachs’ US Treasury bond trader, said that trades reflecting a steeper yield curve and narrower swap spreads have already been fully priced in, and Warsh’s hawkish remarks on the balance sheet are unlikely to translate into a resumption of quantitative tightening. He commented:

*This would be far too damaging to risk assets.*

The market has a habit of misinterpreting the initial stance of a new Fed Chair, and every recent predecessor has had notable "missteps in communication" during their first year in office. Investors are now going through another cycle of misjudging the new Fed Chair, and it will take time for the market to adapt to the new communication style.

## David Mericle, Goldman Sachs Economist: Balance Sheet Reduction Will Prove Difficult, Institutional Framework Is a Fait Accompli

David Mericle sorted out Warsh’s core policy stances:

On interest rates, Warsh called for rate cuts last year, arguing that the Trump administration’s deregulation measures and artificial intelligence are "anti-inflationary forces", and that the Fed should not keep interest rates high merely due to strong economic growth.

On the balance sheet, Warsh has been a long-time critic. He opposed the previous QE2 program, believing that a bloated balance sheet distorts markets, exacerbates inequality and fuels inflation. He advocates combining interest rate cuts with balance sheet reduction to offset each other’s impacts on the financial environment.

Mericle pointed out that he does not expect Warsh to push for a drastic shrinkage of the balance sheet, with the core obstacle being the broad and strong support within the Fed for the current "ample reserves" operational framework. Mericle stated:

*Fed officials have spent more than a decade thinking deeply about this, and the institution has a fairly strong preference for the current approach.*

Most Fed policymakers and staff believe that the growth of the balance sheet relative to the size of the economy is an inevitable result of the accelerated growth in demand for Fed liabilities and the shift to the ample reserves framework for conducting monetary policy. Mericle emphasized that current Chair Jerome Powell delivered a speech a few months ago outlining the advantages of this framework, which is seen as setting the tone for the debate in advance.

Mericle argued that if Warsh wants to reduce the balance sheet without pushing up long-term interest rates, the only realistic path is to relax banking regulation – such as adjusting rules like the liquidity coverage ratio – to lower banks’ demand for reserves, but this will take time and require coordination among multiple parties.

On financial regulation, Warsh believes the current system imposes excessively high compliance costs on banks, especially small and medium-sized ones. He advocates that regulators should be more supportive of mergers among small and medium-sized banks, and has called for the establishment of a new US-specific regulatory regime, rather than fully abiding by the international Basel Accords.

## Goldman Sachs Frontline Traders: Market Reaction May Have Been Excessive

Feedback from Goldman Sachs’ global trading division generally tends to downplay Warsh’s influence.

Brown bluntly stated that market movements reflecting expectations of balance sheet reduction – such as narrower swap spreads and a steeper yield curve – *"now seem to be fully priced in"*. He intuitively believes that Warsh will not actually push to resume quantitative tightening, as it would be overly damaging to risk assets.

Mike Cahill pointed out a key contradiction: Warsh’s past views are inconsistent with the practical commitments required to secure the nomination. He noted:

*We know that being willing to cut interest rates is at the very least a prerequisite for getting this job.*

Cahill said that while the market’s "hawkish balance sheet" trades based on his historical views are understandable, their implementation in reality will take much longer.

Cahill further analyzed that the Fed’s decision-making mechanism is one person, one vote, and compared with the large-scale turnover of the FOMC when Jerome Powell took office in 2017-2018, there have been far fewer personnel changes this time, meaning it will take time for the new Chair to build influence.

He judged that policy coordination between the Fed and the Treasury will increase in the future, and Warsh may accept the Fed holding more short-term Treasury bonds, but a "twist operation" is highly unlikely.

Nikhil Choraria, Head of European Rates Trading at Goldman Sachs, interpreted that Warsh’s "hawkishness" is mainly reflected in his views on the balance sheet, while his "dovishness" lies in "fixing" the structure of the financial system to allow for lower policy rates.

He bluntly stated that these views *"are hard to reconcile with the goal of lowering long-term Treasury yields"* and may need to be led by the Treasury Department.

Will Marshall, European Rates Head at Goldman Sachs, said that it was only natural for the market to initially focus on his past criticisms.

However, he emphasized that the context has changed, considering the Trump administration’s recent focus on "affordability" and the Fed’s own adjustment of its balance sheet policy path at the end of last year to the current framework of providing ample liquidity through Treasury bill purchases. He concluded:

*Ultimately, the market’s assessment of all this will depend largely on economic fundamentals.*

## The Market Always Misjudges the New Chair – History Repeats Itself

Goldman Sachs highlighted that the market’s initial interpretation of Fed nominees often differs drastically from post-facto perceptions.

Every recent predecessor has had notable "communication missteps" in their first year, as they need time to adapt to having every word scrutinized, and the market also needs time to learn the new communication style.

Mike Cahill cited specific examples: Powell’s "a long way from neutral", Yellen’s "coming meetings", and Bernanke’s offhand comments to Maria Bartiromo about how the market would view his testimony.

Synthesizing the judgments of Goldman Sachs’ internal economists and frontline traders, Warsh is a candidate with strong personal beliefs, but he is facing an institution with powerful policy inertia and institutional consensus.

For the market, this means that short-term news volatility surrounding personnel changes may outweigh actual policy shifts. Traders suggested that the potential profit space for yield curve trades based on Warsh’s views on balance sheet reduction may already be very limited.

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