Former Federal Reserve Governor Warsh discussed tariffs and inflation during a Fox interview, expressing sympathy for certain policies under Trump. Warsh suggested a change in economic policies and approach, emphasizing that current inflation stems from money growth rather than high wages.

Warsh referenced past measures during the 2008 crisis, where the Federal Reserve cut rates to zero and implemented quantitative easing. He noted that increasing the balance sheet by a trillion dollars was considered equivalent to a 50 basis point rate cut at the time.

Reducing the Balance Sheet

Warsh proposed that reducing the balance sheet by a few trillion dollars, in coordination with the Treasury Secretary, could act as a significant rate cut. He argued this approach would boost the real economy, despite the current health of financial market conditions, such as a booming IPO market.

According to Warsh, the abundance of money currently benefits the financial sector more than it aids the real economy. He stressed that real economic stimulation could be achieved through actions that effectively reduce rates and bolster economic growth.

The main thrust of Warsh’s remarks revolves around diagnosing the root of current inflation not as a result of wage spirals — which some had feared — but rather due to an outsized expansion in the money supply. This effectively diverts attention away from labour markets and places it on earlier monetary interventions, particularly those surrounding liquidity injections through asset purchases. He appears to be drawing a straight line from monetary decisions made during the post-2008 recovery phase all the way to the present inflationary pressures.

He also points out that in the aftermath of the 2008 crash, aggressive action by the Federal Reserve — most notably cutting interest rates to near-zero and initiating large-scale asset purchases — acted as emergency support for liquidity. He frames those asset purchases as rate cuts by another name, estimating a trillion-dollar expansion of the Fed’s balance sheet to be roughly equivalent to a 50 basis point reduction. This isn’t just a retrospective view; it sets the stage for his current recommendation.

Coordinating Fiscal and Monetary Policy

His suggestion? Find a way to replicate the effect of rate cuts without actually changing policy rates. Specifically, he favours a reduction of the Federal Reserve’s balance sheet, but not in isolation: he sees this working best in lockstep with the Treasury. The nuance here is important — he’s not merely calling for faster quantitative tightening. Rather, he’s advocating for targeted coordination between fiscal and monetary policymakers, aiming to shift excess liquidity away from financial markets, and into the real economy instead. The detail that this could benefit non-financial sectors more directly carries weight, especially since he acknowledges that capital markets are already vibrant, citing a healthy environment for initial public offerings as a case in point.

With that in mind, it’s vital that we recognise where capital has been pooling. Much of it hasn’t trickled into job creation or physical investment, but instead to assets — equities, private placements, digital instruments — anything with yield potential. Warsh’s position challenges whether this capital is still achieving its intended macroeconomic function. For those of us actively pricing risk, that has bearings not just on expected volatility but also on liquidity premia.

Looking ahead, if central banks begin to shrink their balance sheets more assertively — under the premise that this can act as a hidden lever for tightening — the real economy could respond differently compared to conventional rate hikes. That naturally prompts us to reassess duration exposure. It also means that implied rates across derivative structures might fail to capture that tightening element in full, especially if public communication from central banks is soft-pedalled.

We should also keep a close eye on Treasury issuance patterns. If coordination between fiscal and monetary authorities becomes more than rhetorical, and the Fed actively accommodates or even shapes issuance through strategic balance sheet reduction, then the resulting curve shifts could be steep and fast. The front end might remain anchored temporarily, but intermediate tenors could see yield adjustments that break with recent patterns.

This isn’t the time to be lulled by surface-level stability in credit spreads or equity indices. Warsh argues that the activity in asset markets masks the broader inefficiency of transmission into the productive economy. From a modelling perspective, we can no longer treat financial sector signals as fully reliable representatives of macro health. That requires updates to hedging strategies and a closer look at where funding pressures could reappear, especially if liquidity support begins to unwind more abruptly than futures markets project.

If policymakers do steer in this direction, then instruments sensitive to forward guidance — swaps, options on rates, and term premium proxies — may start to show discrete gaps between consensus expectations and realised moves. That presents an opportunity for positioning, but also risk of whipsaw if coordination plays out unevenly.

For now, we price not just policy rates, but the shifting philosophical approach behind them.

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