The market once again misread the Federal Reserve's actions with a knee-jerk reaction. On January 30, 2026, Trump officially nominated Kevin Warsh as the next chairman of the Federal Reserve. Wall Street's first reaction was panic: the dollar soared, U.S. stocks fell, and precious metals were sold off. The reason is simple; the market labeled Warsh as &#34;hawkish.&#34;
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On February 4, Shenwan Hongyuan analyzed in a research report that the market is making the mistake of pricing too quickly. Warsh is not a traditional hawk; his core policy proposition is a hybrid of &#34;balance sheet reduction + interest rate cuts&#34;—to curb long-term inflation expectations by reducing the balance sheet, thereby opening up space for significant interest rate cuts. For investors, this means that the liquidity panic in the short term may be an overreaction. Under the political pressure of the 2026 midterm elections and the heavy burden of U.S. fiscal interest expenditures, interest rate cuts are likely to occur before balance sheet reduction. Investors should not be frightened by short-term fluctuations but should focus on the style switch in U.S. stocks (from large-cap to small-cap), entry opportunities after the volatility of precious metals returns, and the secondary inflation risks that may arise from geopolitical factors affecting oil prices.
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<h2>Misreading &#34;Hawkish&#34;: Warsh's True Intention is to Pave the Way for Interest Rate Cuts</h2>
The research report points out that the market's first reaction to Warsh's nomination was tightening panic, but this overlooks the completeness of his policy propositions. Although Warsh emphasizes that the Federal Reserve must reduce its bloated $7 trillion balance sheet, this is not intended to stifle the economy.
On the contrary, Warsh believes that the current high interest rates do not take into account the productivity improvements brought about by AI. His logical loop is: only by eliminating the &#34;Federal Reserve put option&#34; and long-term inflation expectations through balance sheet reduction can the Federal Reserve have the confidence to make significant interest rate cuts. He even advocates for institutional reform at the Federal Reserve to break free from the dogmatic constraints of the 2% inflation target. Therefore, investors are facing a chairman who is trying to reshape monetary policy through supply-side logic (productivity transformation), rather than a simple rate killer.
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<h2>Reality is Harsh: Political and Fiscal Pressures Force &#34;Rate Cuts First, Balance Sheet Reduction Later&#34;</h2>
Shenwan Hongyuan believes that although Warsh wants to reduce the balance sheet, the reality shows that the Federal Reserve cannot be assertive in the short term.
<blockquote>
<ul>
<li>Liquidity Exhaustion Risk: The liquidity in the U.S. money market has reached a critical point. Reserve balances have significantly decreased, and the usage of overnight reverse repos (ONRRP) has basically dropped to zero. If aggressive balance sheet reduction is recklessly implemented at this time, it will only trigger severe turmoil in the repo market</li>
</ul>
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<ul>
<li>The &#34;tightening spell&#34; of fiscal deficit: Data from 2024 shows that interest expenses account for 18% of U.S. federal fiscal expenditures. If long-term interest rates spiral out of control, the U.S. Treasury will face catastrophic debt repayment pressure. The term premium on U.S. Treasury yields is difficult to manage, and if the Federal Reserve sells U.S. Treasuries, it will be like lifting a stone to drop on its own foot.</li>
</ul>
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<ul>
<li>The political iron law of midterm elections: 2026 is a midterm election year, and Trump's approval ratings are low. Historically, it is highly probable that the ruling party loses seats in midterm elections. To secure votes, the Trump administration urgently needs a loose monetary environment to support the economy and employment.</li>
</ul>
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</blockquote>
Therefore, the research report concludes: Before the midterm elections, the most realistic choice for the Federal Reserve can only be to cut interest rates, while balance sheet reduction will be a long-term process.
<h2>U.S. Stock Strategy: Fluctuations and Style Switching Under High Valuations</h2>
The core issue currently facing U.S. stocks is &#34;expensive.&#34; The dynamic PE of the S&amp;P 500 is as high as 22 times, at the 86th percentile historically. Although the expected earnings growth rate for 2025-2026 exceeds 15%, high valuations require strong performance validation.
The nomination of Walsh has increased market volatility in the short term but has also brought opportunities for style switching. If Walsh promotes a &#34;small government + bank easing&#34; model, small-cap stocks (such as the Russell 2000), which have severely underperformed the market in recent years, will welcome valuation recovery. The valuation of the Russell 2000 relative to the S&amp;P 500 is at a historical low (21.2 percentile), and with the correction of liquidity logic, small and mid-cap stocks, manufacturing, and financial stocks may be more attractive than crowded large-cap growth stocks.
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<h2>Precious Metals and Commodities: Long-term Logic Remains Unchanged, Waiting for Volatility to Return</h2>
Due to the dual impact of signals from &#34;U.S.-Iran talks&#34; and Walsh's nomination, gold and silver have recently plummeted. However, this is more about speculative selling rather than a collapse of long-term logic. The global trend of &#34;de-dollarization&#34; and safe-haven demand remain the cornerstones of a long bull market for precious metals.
From a trading perspective, the implied volatility of Shanghai gold and silver is still at historically extreme high levels. The research report advises investors to be patient, waiting for volatility to decline and the put/call ratio to rebound before positioning on the right side is the best timing.
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For crude oil, if anchored to gold prices, oil prices are currently in an extremely undervalued area. Although Trump tends to suppress oil prices to control inflation, geopolitical factors remain a black swan. If oil prices break through $80 per barrel in the second half of 2026, the U.S. will face the risk of &#34;re-inflation,&#34; at which point the macro asset allocation logic will undergo a dramatic change.
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ShenYinWanGuo believes that the change in leadership at the Federal Reserve has led the market to misinterpret it as a "hawkish" impact, but in fact, Waller is paving the way for "tapering before rate cuts." Due to political and fiscal pressures, rate cuts may come first. This suggests that investors should pay attention to opportunities after the correction of liquidity expectations: the style of U.S. stocks may shift towards small-cap stocks, precious metals still hold long-term value after volatility, while geopolitical factors may drive up oil prices and inflation risks

- The market misinterpreted the implications of Trump's nomination of Kevin Walsh as the next Fed Chair, reacting with panic that led to a surge in the dollar and a drop in US stocks.  
- Walsh's actual approach involves a blend of tightening and rate cuts to address inflation without stifling the economy, and experts predict that rate cuts will occur before any balance sheet reduction due to political and fiscal pressures.  
- Market volatility presents an opportunity for investors to shift into undervalued small-cap stocks and to prepare for an eventual return to normal volatility in precious metals, as Walsh's policies take shape amidst a potentially volatile political landscape ahead of the 2026 midterm elections.

The imminent change in leadership at the Federal Reserve: What is the impact on major asset classes?