The challenge for Kevin Warsh, if he were to lead the Federal Reserve, lies in reducing the Fed's footprint in financial markets without inadvertently tightening financial conditions. Warsh has historically been a vocal advocate for shrinking the balance sheet and placing greater emphasis on inflation stability, earning him a hawkish reputation. Simultaneously, he has recently expressed support for lowering borrowing costs. The primary concern within the industry is that this unconventional combination of stances could lead to tighter financial conditions and create a structurally high-volatility environment across asset classes. Reduced liquidity support from a central bank with a smaller asset portfolio would push market risk premiums higher. Balance sheet reduction could also elevate term premiums, thereby increasing discount rates. This would compress the value of future cash flows, subsequently depressing stock valuation multiples—a dynamic that would hit loss-making or highly leveraged companies the hardest, as investors discount more uncertain, distant earnings and factor in more expensive financing costs.

However, macro strategist Michael Ball points out that despite the various risks inherent in his proposed policies, Warsh holds a trump card: his views on excessive Fed intervention align with those of Treasury Secretary [Bessent], creating the possibility for an informal agreement between the two institutions—which could ultimately benefit risk assets. The "Warsh-Bessent" World Bessent has previously stated on multiple occasions that more predictable bond issuance would curb supply uncertainty. Coupled with an active buyback program and banking regulatory reforms, this would reduce the compensation investors demand when worried about sudden changes in auction sizes and maturity mixes. Ball suggests that in a "Warsh-Bessent" framework, the Fed's balance sheet reduction could be matched with a predictable Treasury debt issuance plan, providing the market with greater clarity on liquidity and supply. If the Treasury's issuance and the Fed's balance sheet reduction path are stable and communicated credibly over the long term, unexpected tightening of financial conditions could be avoided, and any non-forced shocks in the interest rate market would be limited. Combined with Warsh's inclination to cut rates, this dynamic would create room for price increases at the front end of the yield curve. Meanwhile, as the central bank shrinks its balance sheet and debt issuance prospects become more stable, with excess liquidity effectively controlled, any higher term premiums on long-term bonds could be mitigated, collectively reducing premium compensation.

Reforming the Fed's Influence Ball also notes that, beyond the impact on cross-asset volatility, Warsh's preference for the Fed to reduce its influence in financial markets implies that power over fiscal and regulatory reforms would be returned to government officials. This would help strengthen market discipline and restore accountability mechanisms to their pre-global financial crisis state. The potential for regulatory reform is crucial under the Fed's current floor system for interest rates. The fundamental constraint on balance sheet reduction is banks' demand for reserves. Regulatory requirements force banks to hold large amounts of reserves and Treasuries as high-quality liquid assets. Deregulation, by lowering liquidity thresholds and the structural demand for reserves, would suppress volatility in repo transactions and free up dealers' balance sheets, enabling them to intermediate more Treasury supply and matched repo trades. As financial institutions participate more actively and are more willing to use the Fed's liquidity facilities, broader market liquidity and depth would improve, thereby supporting Treasury prices.

Ball also mentions several other policy positions held by Warsh. For instance, Warsh believes that the Fed's forward guidance is "of little use in normal times." Ball indicates that abandoning this practice would alter investor behavior, breaking the market's habit of front-running the Fed, and could even encourage a more fundamentals-oriented framework, reducing reliance on Fed signals. Warsh has also pointed out that long-term Treasuries play a unique role. The yield level and volatility of long-term bonds are arguably the most important prices globally, influencing the valuation of almost all assets. Ball believes that Warsh's proposed reform objectives for the Fed could enhance policy credibility by reducing the size of the balance sheet. If combined with potential coordination with Treasury policy, it would contribute to achieving more stable long-term bond yields.