Warsh advocates for a nuanced Fed policy: simultaneously cutting interest rates while passively shrinking the balance sheet by letting bonds mature. This "passive quantitative tightening" aims to reduce the Fed's market footprint without the shock of active selling, representing a middle ground between aggressive easing and hawkish tightening.

On paper, the Fed is shrinking its balance sheet to cool the economy (quantitative tightening). In reality, rate cuts and other channels are injecting liquidity into the financial system faster than it's being removed. This contradictory policy means that despite official tightening, actual liquidity conditions are already easing, fueling asset prices.

The impending halt of the Fed's balance sheet reduction (QT) is not a reaction to a major economic crisis, but a technical necessity to prevent stress in short-term funding markets as bank reserves become scarce. The Fed is preemptively avoiding a 2019-style repo spike, signaling a quiet return to mild balance sheet expansion.

While political pressure on the Federal Reserve is notable, the central bank's shift towards rate cuts is grounded in economic data. Decelerating employment and signs of increasing labor market slack provide a solid, data-driven justification for their policy recalibration, independent of political influence.

Due to massive government debt, the Fed's tools work paradoxically. Raising rates increases the deficit via higher interest payments, which is stimulative. Cutting rates is also inherently stimulative. The Fed is no longer controlling inflation but merely choosing the path through which it occurs.

A new Fed Chair advocating for a smaller balance sheet cannot simply sell assets without causing market volatility. The Fed must first implement complex, long-term regulatory changes to reduce commercial banks' demand for reserves. This involves coordination with the Treasury and is not a quick policy shift.

The Federal Reserve’s recent policy shift is not a full-blown move to an expansionary stance. It's a 'recalibration' away from a restrictive policy focused solely on inflation toward a more neutral one that equally weighs the risks to both inflation and the labor market.

The Fed plans to align its balance sheet duration with the Treasury's by reducing its holdings of long-term bonds. This would steepen the yield curve by raising long-term rates (hurting mega-caps) while simultaneously cutting the Fed Funds rate to ease pressure on smaller businesses with floating-rate debt.

Current rate cuts, intended as risk management, are not a one-way street. By stimulating the economy, they raise the probability that the Fed will need to reverse course and hike rates later to manage potential outperformance, creating a "two-sided" risk distribution for investors.