Trump expects his Fed chair nominee to cut interest rates. Here’s how Kevin Warsh might try to do it.

When President Donald Trump selected Kevin Warsh to be the next head of the Federal Reserve, the conventional wisdom was that Warsh must have somehow convinced the president that he would be able to persuade his fellow central bankers to lower interest rates.

But how?

It’s been clear for months that there’s not much support for lowering rates among the 19 top Fed policymakers. Stephen Miran, the Fed governor with the closest ties to the Trump White House, has been a lonely voice calling for deep rate cuts.

But there is one way Warsh might be planning to get Fed officials to go along with monetary-policy easing, according to economists: by shrinking the Fed’s balance sheet. 

Warsh’s previous speeches suggest he believes that shrinking the balance sheet by $1 trillion has an effect on the economy equivalent to an interest-rate hike of 50 basis points.

Warsh will press his Fed colleagues to cut short-term rates to offset such a tightening of the balance sheet, said Joe Gagnon, a fellow at the Peterson Institute for International Economics.

Essentially, Warsh would be tightening policy with one hand while easing with the other. But it would get interest rates down.

“Shrinking the balance sheet may indeed be an argument Warsh leans into as to why rates should be lower,” said Mark Cabana, head of U.S. rates strategy at BofA Global Research. 

Warsh has been a vocal critic of the size of the central bank’s balance sheet, which has ballooned to over $6 trillion, up from under $1 trillion before the 2008 financial crisis. 

The Fed now holds $1.6 trillion in long-term Treasurys and $1.9 trillion in mortgage-backed securities. This is a large “footprint” in financial markets.

Source: InvestorWatch