--- title: "The Federal Reserve's \"Warsh Era\" has begun! \"Balance Sheet Reduction + New Inflation Framework\" is coming on strong, and the U.S. stock market bull market is facing a stress test" type: "News" locale: "en" url: "https://longbridge.com/en/news/286506352.md" description: "The new chairman of the Federal Reserve, Kevin Warsh, will promote the deleveraging of the balance sheet and reforms to the inflation analysis framework, which may put pressure on the bull market in the U.S. stock market. The market needs to digest more long-term debt supply, and the term premium may rise, leading to an increase in the discount rate for overvalued assets. Warsh's reforms will be gradual and may affect the valuations of indices such as the Dow Jones, S&P 500, and NASDAQ" datetime: "2026-05-15T04:13:33.000Z" locales: - [zh-CN](https://longbridge.com/zh-CN/news/286506352.md) - [en](https://longbridge.com/en/news/286506352.md) - [zh-HK](https://longbridge.com/zh-HK/news/286506352.md) --- # The Federal Reserve's "Warsh Era" has begun! "Balance Sheet Reduction + New Inflation Framework" is coming on strong, and the U.S. stock market bull market is facing a stress test The term of Federal Reserve Chairman Jerome Powell is coming to an end, and his successor Kevin Warsh intends to change the Federal Reserve in two ways—however, both are likely to disrupt the U.S. stock market, which is crucial for the entire U.S. economy, as it is currently at historically high levels in terms of benchmark index points and valuations. The important day has finally arrived. May 15 will be the last day of Jerome Powell's tenure as Federal Reserve Chairman and is also expected to be the day Kevin Warsh begins his first term as Chairman of the Federal Reserve. Warsh served on the Federal Reserve Board for five years (from February 24, 2006, to March 31, 2011), during which time he gained significant experience as a key leader, coinciding with the global financial crisis. However, the Federal Reserve under Warsh's leadership will bring changes to the central bank—changes that could threaten the recent record highs of the Dow Jones Industrial Average, S&P 500, and NASDAQ Composite Index, driven by the narrative of an AI computing power bull market. For the financial markets, the combined effect of Warsh's initiatives to de-leverage the Federal Reserve's balance sheet and to redefine or reshape the Fed's framework for analyzing inflation will increase the pressure on the discount rates of overvalued assets. With inflation still high, energy shocks unresolved, and employment remaining resilient, it will be difficult for the new chairman to quickly pivot to interest rate cuts; however, if he simultaneously advances balance sheet reduction, weakens excessive forward guidance, and strengthens the priority of price stability, the market will gradually shift from "Powell-era interest rate cut expectation trading" to "Warsh-era term premium and inflation credibility trading." This would mean that long-term yields of 10 years and above in the U.S. bond market would find it harder to decline quickly, which in turn would limit the valuation expansion space for risk assets such as global stock markets; it could also provide temporary support for the U.S. dollar. **Kevin Warsh plans to de-leverage the Federal Reserve's balance sheet** Warsh's core reform directions include the balance sheet, inflation analysis, and changes in the internal technology/money policy culture of the central bank, but these changes are likely to be implemented gradually. It can be said that Warsh's long-standing criticism of the world's largest central bank is due to its increasingly bloated balance sheet. From August 2008 to March 2022, the total assets held by the Federal Reserve grew nearly tenfold, approaching $9 trillion. Although the previous round of (now-ended) quantitative tightening helped reduce this figure to $6.7 trillion as of May 6, 2026, Powell's successor clearly aims to significantly reduce the leverage of the balance sheet. The issue is not whether selling these assets, primarily composed of U.S. Treasury bonds and mortgage-backed securities (MBS), is right or wrong. The problem is that selling trillions of dollars of long-term U.S. Treasury bonds could bring a series of unexpected pessimistic consequences to Wall Street. Bond prices and yields have an inverse relationship. The sale of trillions of dollars in U.S. Treasury bonds will depress bond prices and significantly raise yields, thereby increasing the long-term benchmark borrowing costs for consumers and businesses. Even if Waller and other members of the Federal Open Market Committee (FOMC)—the highest-level body responsible for formulating U.S. monetary policy, consisting of 12 members—do not intend to advance the interest rate hikes that the market is actively pricing in, the deleveraging of the Federal Reserve's balance sheet will effectively have a similar tightening effect as raising interest rates. A stock market at historically high valuation levels is relying on lower interest rates to drive the unprecedented construction of artificial intelligence data centers and other costly projects that could change the trajectory of U.S. economic growth. In other words, even if the FOMC does not directly push for interest rate hikes, as long as the Federal Reserve accelerates the sale or reduction of its holdings of long-term U.S. Treasuries and MBS, it will depress bond prices and raise long-end yields, effectively achieving implicit tightening through the "term premium" channel. The so-called term premium refers to the extra yield compensation that investors require for holding long-term bonds. A policy study by the IMF in 2025 has clearly found that after a significant deterioration in fiscal conditions, the link between deficits and interest-bearing debt with higher long-term rates and higher term premiums has significantly strengthened. Capital Group points out that quantitative easing and reversal operations have previously depressed term premiums, while Waller's long-standing criticism of the size of the Federal Reserve's balance sheet suggests that long-end yields will be more driven by inflation expectations, fiscal dynamics, global demand for U.S. Treasuries, and term premiums. The 10-year U.S. Treasury yield is known as the "anchor of global asset pricing." If this yield indicator continues to rise under the influence of term premiums driven by fiscal stimulus, it will undoubtedly lead to a new round of valuation collapse for high-yield corporate bonds, technology stocks closely associated with the global stock market bull run driven by AI, and even cryptocurrencies, which are among the hottest risk assets globally. If the yields on U.S. Treasuries with maturities of 10 years or more continue to rise, it would mean that for the stock market, cryptocurrencies, and core risk assets like high-yield corporate bonds, there will be a simultaneous occurrence of "significantly elevated funding costs + weakened liquidity expectations + expanded macro denominators." **Powell's successor wants to change your understanding of inflation** In addition to reducing the central bank's $6.7 trillion balance sheet, Powell's successor explicitly stated during testimony before the Senate Banking Committee that he hopes to change the economic definition of "inflation" used by the Federal Reserve and even global central banks. Since January 2012, the Federal Open Market Committee has maintained a tough monetary policy target of a 2% long-term inflation goal. However, according to Waller, "price stability should be a dynamic state of price changes such that no one talks about it during that period." This idea, which seems to hope to abandon the strict inflation target in favor of a noticeably more ambiguous definition of price changes, should give the Federal Reserve greater flexibility in adjusting its monetary policy stance or taking action. While this may sound beneficial on paper, it carries significant risks of disrupting Wall Street's strong bull market, and even institutional investors are concerned that Waller's move is aimed at better advancing President Trump's long-desired "rate cut plan" in the context of current high inflation Since the start of the Iran War on February 28, energy prices have surged. The closure of the Strait of Hormuz has led to the largest energy supply disruption in modern history, driving a decisive rise in inflation over the past 12 months. There is no doubt that American consumers and businesses have recently been discussing inflationary pressures. If Walsh successfully changes the way the Federal Open Market Committee weighs inflation, the price pressures brought about by the Iran War may soon prompt more FOMC members to shift towards a neutral or rate-hiking stance. Despite the strong performance of the Dow Jones Industrial Average, S&P 500, and NASDAQ Composite Index amid rapidly rising inflation, a decisive shift by the Federal Reserve led by Walsh could quickly change Wall Street's tone towards the stock market. Walsh has suggested that price stability should be a state in which "no one is talking about price changes." This means he may not just mechanically focus on the 2% target, but rather pay more attention to whether inflation has entered public consciousness, corporate pricing, wage negotiations, and financial market expectations. On the surface, this provides greater flexibility for policy; however, financial giants on Wall Street, such as JP Morgan, have recently indicated that under the current backdrop of the Iran War pushing up energy prices and U.S. inflation re-accelerating, this framework could also lead the currently hawkish FOMC to shift more quickly towards a "rate-hiking stance." Compared to many hawkish representatives, Walsh, as the Federal Reserve Chair, only has one vote. The influence of the Federal Reserve Chair is significant, as they can lead the agenda, communicate frameworks, and shape market expectations, but in the FOMC voting mechanism, they are essentially just one voting member. If the majority of members believe that inflationary pressures do not allow for rate cuts, it will be difficult for Walsh to unilaterally push a dovish path. In the context of oil price shocks and re-accelerating inflation, even if Walsh himself faces political pressure for rate cuts, the hawkish consensus within the FOMC may force the Federal Reserve to maintain high rates for a longer period, or even reopen the risk of rate hikes; as Chair, Walsh has strong agenda and communication power, but cannot bypass the majority opinion of the committee. **The U.S. Treasury market braces for the 5% era, as balance sheet reduction disputes tear open internal fissures within the Federal Reserve** For the financial markets, the most important factor is not whether Walsh personally "wants to cut rates," but whether the bond market believes he can maintain the Federal Reserve's credibility against inflation. If Walsh prematurely releases dovish signals in the context of high inflation, long-term U.S. Treasuries may "punish" the policy shift through unanchored inflation expectations and rising term premiums, pushing the 10-year yield close to or even testing 5%. The higher the oil prices, the harder it is for inflation to fall back, and the more investors demand higher compensation; a rise in the 10-year yield will increase mortgage, corporate debt, leveraged loan, and stock valuation discount rates, directly suppressing the high valuations of U.S. stocks and the narrative of AI capital expenditures. Walsh's deeper policy preference is to promote the normalization of the Federal Reserve's balance sheet. He has long criticized the large-scale bond purchases during the crisis for resulting in an oversized Federal Reserve portfolio, which may distort market prices; currently, the Federal Reserve's asset size is approximately $6.7 trillion, still far above pre-financial crisis levels The problem is that balance sheet reduction is not technically neutral: reducing the Federal Reserve's holdings of Treasury bonds and MBS means removing an important marginal buyer, which will increase the duration supply that the market needs to absorb, depress bond prices, raise long-term yields, and potentially steepen the yield curve. Federal Reserve Governor Barr publicly opposed reducing the Fed's asset size by lowering bank liquidity rules, stating that "shrinking the balance sheet is the wrong goal," and many related proposals would weaken bank resilience, hinder money market operations, and threaten financial stability; he also emphasized that the lesson from the banking stress events in 2023 is not to lower liquidity requirements, but rather that liquidity requirements should be increased. All of this suggests that after Walsh takes office, he will likely face two fronts: one is the external market front, where investors demand he demonstrate the Fed's independence between inflation and political pressure; the other is the internal institutional front, where Fed governors, regional Fed presidents, and regulatory factions impose constraints on aggressive balance sheet reduction. New York Fed President Williams, Governor Waller, and others have previously expressed skepticism about returning to a "scarce reserves" framework, indicating that there is not unanimous support within the Fed for reducing the balance sheet by lowering reserves and weakening liquidity requirements, which means Walsh must first establish a consensus within the FOMC to advance balance sheet reform. If consensus is slow to form, the policy path may present a combination of "interest rates remaining unchanged, cautious balance sheet reduction, and the market continuously trading the risk of rising long-end yields." ### Related Stocks - [.DJI.US](https://longbridge.com/en/quote/.DJI.US.md) - [.NDX.US](https://longbridge.com/en/quote/.NDX.US.md) - [.IXIC.US](https://longbridge.com/en/quote/.IXIC.US.md) - [.SPX.US](https://longbridge.com/en/quote/.SPX.US.md) - [ONEQ.US](https://longbridge.com/en/quote/ONEQ.US.md) - [DIA.US](https://longbridge.com/en/quote/DIA.US.md) - [IVV.US](https://longbridge.com/en/quote/IVV.US.md) - [SPY.US](https://longbridge.com/en/quote/SPY.US.md) - [QQQ.US](https://longbridge.com/en/quote/QQQ.US.md) - [VOO.US](https://longbridge.com/en/quote/VOO.US.md) - [QQQM.US](https://longbridge.com/en/quote/QQQM.US.md) - [JPM.US](https://longbridge.com/en/quote/JPM.US.md) - [JPM-M.US](https://longbridge.com/en/quote/JPM-M.US.md) - [JPM-C.US](https://longbridge.com/en/quote/JPM-C.US.md) - [JPM-D.US](https://longbridge.com/en/quote/JPM-D.US.md) - [JPM-L.US](https://longbridge.com/en/quote/JPM-L.US.md) - [8634.JP](https://longbridge.com/en/quote/8634.JP.md) - [JPM-K.US](https://longbridge.com/en/quote/JPM-K.US.md) - [JPM-J.US](https://longbridge.com/en/quote/JPM-J.US.md) ## Related News & Research - [Big changes are coming to the Federal Reserve tomorrow, and it could spell trouble for Wall Street](https://longbridge.com/en/news/286414207.md) - [Fed's Miran says he will vacate board seat on or just before Warsh is sworn in as chair](https://longbridge.com/en/news/286453846.md) - [LIVE MARKETS-History favors more gains after April's surge, Carson Group says](https://longbridge.com/en/news/285754286.md) - [The bond market is already hiking rates as Kevin Warsh takes over as Fed’s new chair](https://longbridge.com/en/news/286476010.md) - [More from Fed's Barr - hasn't decided on what to do at June FOMC meeting](https://longbridge.com/en/news/286484533.md)