Core Viewpoint - The proposed "balance sheet reduction + interest rate cut" policy by Kevin Warsh, the nominee for the new Federal Reserve Chair, is seen as an attempt to reconstruct the monetary policy framework rather than a mere technical adjustment. The key role of balance sheet reduction could profoundly impact future liquidity patterns and asset pricing [3][10]. Summary by Sections Policy Objectives - The aim of balance sheet reduction is to decrease the Federal Reserve's intervention in financial markets, restore market price discovery, and reserve policy space for future crises. Ultimately, it seeks to shift the monetary system from "exogenous supply" back to "endogenous creation" [3][9]. Implementation Challenges - While there are constraints to implementing balance sheet reduction, it is not unfeasible. Effective coordination among financial regulation, monetary policy, and fiscal policy is crucial. Steps include optimizing capital regulation rules to reduce banks' reserve requirements and managing liquidity tools to enhance predictability in Treasury issuance [4][16]. Market Implications - Anticipated changes in monetary policy typically precede actual policy actions. A shift from exogenous to endogenous monetary systems implies that the supply of safe assets will transition from abundance to relative scarcity, which could negatively impact risk assets, particularly those reliant on liquidity [5][30]. Financial System Dynamics - The transition to an endogenous monetary system is expected to enhance the traditional safe asset status of U.S. Treasuries. In an exogenous framework, increased fiscal deficits lead to more Treasury issuance, while in an endogenous framework, the relative scarcity of safe assets could increase demand for bonds during economic slowdowns [5][31]. Steps for Balance Sheet Reduction - A feasible path for balance sheet reduction involves a gradual, multi-faceted approach, including relaxing financial regulations, maintaining a relatively scarce reserve level, and ensuring predictable Treasury issuance. This process is expected to take at least six months, with potential implementation by the end of this year or early next year [16][18]. Asset Selection - The Federal Reserve is likely to prioritize reducing its holdings of Mortgage-Backed Securities (MBS) over Treasury securities, as this aligns with the goal of reducing duration and minimizes the need for cross-department coordination [19][20]. Economic Recovery and Interest Rates - The combination of balance sheet reduction and interest rate cuts aims to lower financing costs, stimulate credit expansion, and support economic recovery. This is particularly relevant for sectors sensitive to interest rates, such as real estate and manufacturing [20][32].