China Gold: Wash's policy proposals and their potential impact

China International Capital Corporation (CICC) released a research report stating that on January 30, 2026, Donald Trump nominated Kevin Walsh as the next Federal Reserve Chairman. Walsh advocates for reducing interest rates through a combination of balance sheet reduction and rate cuts, and also proposes a "structural adjustment" of the Federal Reserve to rebuild the credibility of monetary policy. CICC believes that Walsh's "hawkish" stance mainly reflects in the Federal Reserve's balance sheet issues, while he is more "dovish" when it comes to rate cuts. Trump nominated him not only because of his preference for lowering interest rates but also because of his advocacy for restructuring the long-standing monetary policy framework dominated by establishment figures, aligning with Trump's political narrative of breaking old systems. In the short term, Walsh's nomination has limited impact on the interest rate trajectory but may lead to adjustments in the expectations of US dollar liquidity, potentially easing the pressure of dollar depreciation. Speculative assets driven by liquidity may be more vulnerable to shocks. In the medium term, Walsh's proposals face constraints from within the Federal Reserve, financial markets, and fiscal policies, making it difficult to determine their success. However, it is equally important not to underestimate his willingness to make policy adjustments. Trump's "America First" policy mindset may gradually manifest in the Federal Reserve's policy practices in the coming years. Investors should prepare for potential changes and be proactive. Key points from CICC's analysis include: 1. What are Walsh's core views? Walsh's most distinctive view is to reduce interest rates through a combination of balance sheet reduction and rate cuts. He believes that the current Federal Reserve policy framework is ineffective in pushing rates lower. Since September 2024, despite a cumulative 175 basis points rate cut by the Fed, long-term Treasury yields have not fallen but risen, indicating a decline in the market's trust in the Fed. Walsh proposes shrinking the balance sheet to create more space for rate cuts. He views balance sheet expansion as having an "equivalent rate cut" effect, where each one trillion increase in the balance sheet equates to a 50 basis point rate cut. Walsh leans slightly "hawkish" on inflation, aligning with Friedman's monetarist view that inflation stems from monetary expansion. He has argued that inflation is a choice rooted in the Fed's money printing rather than external factors like tariffs or pandemics. Walsh has also opposed QE during his tenure as a Fed governor, suggesting it should be used only in emergencies and not as a permanent policy tool. Having policymakers, namely members of Congress, aware that the government's financing costs are being subsidized by the central bank would make appropriation decisions more casual. Walsh also advocates for a "regime change" at the Federal Reserve to rebuild the credibility and institutional framework of monetary policy. He is against models and forward guidance-based operating frameworks, urging the Fed to halt predicting rate paths and return to a results-oriented, highly discretionary policy mode. He has stated that "Americans don't need a weekly progress report; they need stable prices. The economy cannot be simplified into models or machines; in a rapidly changing environment, the Fed must have full autonomy to adjust policy." In the financial sector, Walsh advocates for "America First," suggesting simplifying the complex rules of the Basel agreement affecting US banks. He also recommends a comprehensive review of the entire Dodd-Frank financial regulatory system, especially considering the impact of the end of the era of "cheap money" on bank liquidity and solvency. Walsh believes that the Fed and the Treasury should jointly conduct a fundamental assessment against this backdrop. 2. Why did Trump choose the somewhat "hawkish" Walsh? Firstly, Walsh's "hawkish" views are mainly evident in managing the Fed's balance sheet, while he is more "dovish" on interest rate cuts. As mentioned earlier, Walsh attributes inflation to the Fed's monetary expansion, suggesting that by managing the money supply effectively, inflation can be controlled, consequently enabling credible rate cuts. With the upcoming midterm elections, Trump needs voters to see concrete changes and benefits, an aspect where Walsh aligns given his similar pursuits. He has noted that interest rate policy is housing policy, with the current US real estate market in a recession, making it difficult for first-time homebuyers to afford homes due to high mortgage rates. Sincere rate cuts lower the entire yield curve, leading to economic recovery, beneficial for business profits and financial markets. Secondly, Trump aims to lower interest rates, with Walsh's reputation as a "hawk" in financial markets seen as favorable for lowering rates. While the Fed controls short-term rates, it is the long-term rates that impact real economy costs like mortgages and car loans. History demonstrates that dovish rate cuts under political pressure can quickly ignite inflation fears, raising long-term rates instead of lowering them. A figure like Walsh, having credibility as a hawk, can make the market believe he would decisively act when inflation rises to rein it in, anchoring inflation expectations. While seemingly a paradox in monetary policy, rebuilding credibility actually stabilizes inflation expectations, a path to overcoming inflation worries and reaching lower rates in the long run. Thirdly, Trump wants to break old systems and establish new rules, aligning with Walsh's policy adjustments aimed at restructuring the long-standing monetary frame led by establishment figures, fitting this political narrative. The current Fed's framework evolved over the past forty years amidst globalization, influenced by conventional wisdom and globalist thinking. However, this framework failed to address structural contradictions in the US economy. Post the 2008 housing crisis, continuous QE by the Fed caused liquidity flooding and asset price inflation; post the COVID-19 pandemic, the Fed's "deluge" led to high inflation, further eroding purchasing power for ordinary families. Treasury Secretary Benson had criticized the Fed as a "facilitator of wealth and income inequality." Trump's choice of Walsh represents a return to conservative thinking, indicating a desire to shift Wall Street benefits to Main Street. Walsh's broad financial network on Wall Street gives him an advantage in coordinating various interests; also, he has the natural ability to communicate effectively with capital markets. These aspects aid in achieving Trump's policy goals. 3. What are the implications for the interest rate trajectory? The short-term impacts on interest rates are limited, with growing uncertainties after June. The Fed currently relies on forward guidance and expectation management, unlikely to significantly change before Walsh assumes office in June; officials will likely adhere to the existing framework. Attention should focus on how Walsh will drive rate cuts after taking office. Under his framework, rate cuts must depend on anchored inflation expectations, managed Fed balance sheet, and constrained fiscal policies. This indicates Walsh emphasizes the "quality of rate cuts" rather than continuous cuts. Therefore, CICC maintains its view that the Fed could cut rates twice this year, but the timing is more likely post-June. Given Walsh's resistance to decision-making based on models and forward guidance, he may weaken the effectiveness of economic forecasts and dot plots, possibly even advocating the abolition of dot plots, making future rate cut paces harder to anticipate beforehand. Furthermore, Walsh could push for a new "fiscal-monetary coordination mechanism," akin to the 1951 Fed-Treasury Accord establishing central bank independence. Walsh believes inflation arises from government overspending and money expansion, calling to lower long-term rates, not just rely on Fed operations but rebuild fiscal discipline. Genuine fiscal-monetary coordination means the Fed doesn't foot the bill for fiscal deficits indefinitely but collaborates with Treasury to control inflation expectations and create sustainable rate-cutting space. If realized, this envisaged setup could lower the long-term neutral rate and lead to an overall yield curve shift downwards. 4. What are the implications for US dollar liquidity? Market narratives on liquidity flooding may face adjustments. Walsh's clear opposition to QE hints that the Fed's massive balance sheet expansion might decrease under normal circumstances. Reflecting on financial regulation, Walsh once stated the liquidity-driven "holiday" had ended, and the conclusion of the cheap money era could impact bank liquidity and solvency. Walsh envisions transitioning from extreme ease to marginal tightening of liquidity. For markets, assets solely fueled by liquidity face vulnerability. Following Walsh's nomination, assets like gold, silver, and bitcoin, which had seen rapid growth, experienced significant declines. Simultaneously, the US dollar rebounded notably, with US Treasury market reactions relatively flat. These trends suggest the market expects the Fed to rebuild credibility, lessening the recent dollar depreciation pressures due to the "sell-off America" narrative. Strengthened credibility also benefits bond market stability, with stable bond yields preventing unnecessary market panics. In the medium term, if Walsh's views materialize, the global financial system could eventually face a scarcer but stable dollar environment. Throughout the past forty years of globalization, the dollar acted as a reserve currency, playing a role as a "global public good." As the US accelerates reconfiguring industrial chains, reducing dependence on foreign imports, its external financial obligations may reduce too. In the new "America First" landscape, the dollar system might increasingly serve US internal goals, making dollar liquidity, as a financial resource, not as ample as before. 5. Resistance and risks to Walsh's policy adjustments Any reform comes with obstacles, and Walsh is no exception. Three key constraint sources for Walsh include resistance from within the Fed, capital markets, and fiscal policies. Internal resistance, typically the first to emerge, may prove challenging as the Fed's framework currently revolves around collective decision-making; pushing policy reforms would require support from other officials. Many of these officials have establishment backgrounds and intricate connections to Wall Street, likely to impede progress on some issues and slow policy adjustment processes. Moreover, how do capital markets perceive Walsh's proposals? Will overly radical agendas trigger negative reactions? For example, Walsh's stance on balance sheet reduction could raise concerns about liquidity tightening, leading to asset price declines if communication falls short. Amid midterm election backgrounds, significant market adjustments would be unfavorable to Trump and the Republican party, potentially forcing a "tactical retreat" (TACO). In the past year, radical policies have caused market plunges, prompting Trump to eventually "back down." Lastly, Walsh's policy adjustment plans require fiscal cooperation; a lack of fiscal discipline may invite back the "bond vigilantes," exacerbating financial risks. Walsh emphasizes fiscal control to reduce deficits, diminish bond supplies, while the Fed curbs buying treasuries, guiding lower inflation expectations and long-term yields. While Treasury Secretary Benson had promised to reduce the deficit rate to 3% prior to office, fiscal inertia and resistance impede spending cuts. CICC expects the US deficit rate to remain around 6% in the coming years, posing challenges to reshaping fiscal-monetary coordination and macro policy discipline. Faced with these challenges and risks, CICC anticipates Walsh will adopt a more pragmatic approach in the short term, avoiding radical actions. However, in the medium term, he aims to establish a monetary system aligned with Trump's "America First" strategy, with his conservative roots unlikely to change easily. Therefore, investors should not underestimate his willingness for policy adjustment and should be prepared for potential shifts in US monetary policy thinking and their spillover effects.