Strange phenomenon: Trump repeatedly emphasizes interest rate cuts, but the candidates for the new chair of the Federal Reserve collectively discuss "balance sheet reduction."

Despite President Trump's continuous public pressure to lower interest rates, the leading candidates for the next Federal Reserve Chair have shifted the focus of policy discussions to limiting the central bank's balance sheet size—a policy inclination that may run counter to the president's desire for low rates.

This debate about the role of the Federal Reserve comes at a critical moment as the White House is actively searching for Powell's successor. According to POLITICO, Treasury Secretary Janet Yellen, who is overseeing the search, along with several key candidates on the shortlist, have publicly expressed concerns about the Federal Reserve's significant market influence, suggesting a potential shift towards a more restrained policy path in the future.

The latest developments indicate that major candidates, including former Federal Reserve Governor Kevin Warsh and current Governor Michelle Bowman, have sent similar signals. Warsh called on Fox Business Channel in a populist tone to "pull money out of Wall Street," while Bowman advocated for maintaining "as small a balance sheet as possible." These statements sharply contrast with Trump's demand to lower borrowing costs by any means necessary.

For investors, the crux of this debate lies in whether the Federal Reserve will still utilize quantitative easing (QE) as a powerful tool in response to economic downturns, as it has in the past. The choice of the next chair will directly determine the U.S. central bank's policy arsenal and willingness to act in the coming years, profoundly impacting global capital market expectations and trends.

The "Hawkish" Consensus Among Candidates

In the race for the next Federal Reserve Chair, a "hawkish" consensus seems to be forming around limiting the central bank's market interventions. These candidates generally believe that the Federal Reserve's balance sheet, exceeding $6 trillion, is already too large.

• Kevin Warsh: As a former Federal Reserve Governor, Warsh has advocated for limiting the central bank's size for nearly 15 years. He believes that reducing the balance sheet could create room for the Federal Reserve to lower short-term rates without triggering inflation, although this view is not universally accepted.

• Michelle Bowman: As a current Federal Reserve Governor, Bowman's logic is that a smaller balance sheet would provide "more room to respond to future shocks or economic downturns," without the concern of insufficient space when expanding tools.

• Yellen: Treasury Secretary Yellen, who is leading the selection process, has also been mentioned by Trump as a potential candidate. In a lengthy 5,000-word article, she explicitly stated that the central bank needs to commit to "reducing its distorting impact on the market." Although she clarified in interviews that her views are more focused on being cautious about future asset purchases rather than immediate contraction, she acknowledged that "reform" is one of her key focuses in this search.

Trump's Contradictory Position

The candidates' focus on "balance sheet reduction" directly conflicts with Trump's own policy preferences and past statements. Trump is known for his "improvised policy style," and his primary concern is lowering interest rates to alleviate the federal government's debt interest and stimulate mortgage lending A compelling example occurred in December 2018. At that time, the Federal Reserve was reducing its asset holdings by up to $50 billion per month, and Trump directly tweeted in an obscure message: “Stop with the 50 B’s,” expressing concern that this move would drain liquidity from key financing markets.

This raises a core question: Did Trump hope to weaken the Federal Reserve's influence on the market to align with the Republican tradition of small government, or did he wish to leverage that influence to satisfy his desire for as low interest rates as possible? Currently, the answer is unclear.

The Policy Logic Behind "Balance Sheet Reduction"

The calls from candidates to reduce the balance sheet stem from Republicans' long-standing concerns about quantitative easing (QE). QE is an unconventional tool used by central banks to lower long-term interest rates by purchasing U.S. Treasury bonds and mortgage-backed securities after short-term rates have fallen to zero.

Opponents argue that this policy has multiple drawbacks:

1. Disrupting Market Discipline: Injecting large amounts of cash into the financial system disrupts normal pricing and risk-clearing functions in the market.

2. Encouraging Government Spending: Bessent pointed out in her article that the Federal Reserve's asset purchases created space for Congress to engage in large-scale fiscal spending after the COVID-19 pandemic.

3. Exacerbating Wealth Inequality: By artificially inflating asset prices, QE has been accused of worsening the wealth gap.

Of course, not everyone shares this view. Current Chairman Powell defended QE last month, stating that it was a “critical tool” during the crises of market dysfunction and soaring unemployment in 2020, although he also acknowledged that the asset purchases in 2021 may have lasted too long in hindsight.

Market Outlook and Final Choices

Regardless of how this debate unfolds, the short-term path for the market seems to be set. The Federal Reserve plans to stop reducing its balance sheet on December 1 to prevent liquidity issues in the financial system. This decision has the support of Stephen Miran, the White House Chief Economist and current Federal Reserve Governor. Miran also pointed out that as the central bank gradually replaces its mortgage-backed securities with short-term U.S. Treasury bonds, the market will still bear more long-term debt risk.

Looking ahead, Miran stated that he does not oppose the use of QE when the Federal Reserve's dual mandate of employment and price stability faces “credible and significant risks.”

Ultimately, whoever takes over the Federal Reserve after Powell's term ends in May next year may face the reality of “being in the trenches with no atheists.” When the economy truly falls into recession and the cost of living becomes a primary issue for the public, any chairman appointed by Trump may feel the need to utilize all available policy tools. However, until then, this debate about the future role of the Federal Reserve will continue to bring uncertainty to the market