The "Powell Era" of the Fed has begun! "Balance sheet reduction + new inflation framework" is gaining momentum, and the bull market in US stocks faces a stress test.

Federal Reserve Chairman Powell's term is coming to an end, and his successor, Kevin Wash, intends to make changes to the Federal Reserve in two waysboth of which may disrupt the benchmark index points and valuations in the US stock market, which are currently at record highs. The important day has finally come. May 15th will be the last day of Jerome Powell's tenure as Federal Reserve Chairman, and it is expected to be the day Kevin Wash begins his first term as Federal Reserve Chairman. Wash previously served as a member of the Federal Reserve Board for five years (from February 24, 2006, to March 31, 2011), a period that coincided with the global financial crisis, providing him with crucial experience for his role as a key leader. However, the changes that Wash will bring to the Federal Reserve are likely to pose a threat to the recent historic highs of the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite, driven by the narrative of the AI computing power bull market. For the financial markets, Wash's leadership in driving the Federal Reserve's balance sheet deleveraging and redefining or reshaping the Fed's inflation analysis framework will collectively increase the pressure to discount high valuation assets. Given the high inflation, unresolved energy shocks, and resilient employment, the new chairman is unlikely to quickly switch to easing; but if he simultaneously pushes for balance sheet reduction, weakens excessive forward guidance, and strengthens the priority of price stability, the market will gradually shift from "Powell era easing expectations trading" to "Wash era term premium and inflation credibility trading". This implies that long-term yields of 10 years and above in the US bond market will be more difficult to decline rapidly, further limiting the valuation expansion space for global stock markets and other risk assets; and may provide temporary support for the US dollar. Kevin Wash intends to deleverage the Federal Reserve's balance sheet Wash's core reform directions include the balance sheet, inflation analysis, and internal technical/cultural changes at the central bank, but these changes are likely to be gradual. Wash has long been critical of the Federal Reserve's massively expanded balance sheet during the crisis, with the central bank's total assets increasing about tenfold from August 2008 to March 2022, to nearly $9 trillion. Although the previous round of (now ended) quantitative tightening helped reduce this figure to $6.7 trillion as of May 6, 2026, Powell's successor clearly hopes to significantly reduce the leverage of the balance sheet. The issue is not whether selling these assets, mostly consisting of US Treasury securities and Mortgage-backed Securities (MBS), is right or wrong. The problem is that selling trillions of dollars of long-term US Treasuries could have a series of unexpected negative consequences for Wall Street. Bond prices and yields have an inverse relationship. Selling tens of trillions of US Treasuries will depress bond prices and substantially increase yields, thereby raising the long-term benchmark borrowing costs for consumers and businesses. Even if Wash and the other members of the Federal Open Market Committee (FOMC)the highest-level institution of 12 people responsible for formulating US monetary policydo not intend to push forward market expectations of interest rate hikes, deleveraging the Federal Reserve's balance sheet will effectively have a similar tightening effect as raising interest rates. A stock market at historically high valuations is relying on lower interest rates to drive unprecedented investments in artificial intelligence data centers and other costly projects that can change the trajectory of US economic growth. In other words, even if the FOMC does not directly increase interest rates, as long as the Federal Reserve accelerates the sale or reduction of long-term US Treasuries and MBS holdings, it will depress bond prices, raise long-term yields, and effectively tighten monetary policy through the "term premium" channel. The term premium refers to the additional government bond yield compensation investors demand for holding long-term bonds. An IMF policy study in 2025 explicitly found that after a significant deterioration in fiscal conditions, there was a significant strengthening in the connection between deficits, interest-bearing debt, and higher long-term rates and term premiums. Capital Group points out that quantitative easing and Twist operations have lowered term premiums in the past, and Wash's long-standing criticism of the size of the Fed's balance sheet suggests that long-term yields will be more driven by inflation expectations, fiscal dynamics, global demand for US Treasuries, and term premiums. The 10-year US Treasury yield is known as the "anchor of global asset pricing". If this yield indicator continues to rise due to term premium-driven fiscal stimulus, it will undoubtedly lead to a new round of valuation collapses for high-yield corporate bonds, technology stocks closely tied to AI driving the global stock market bull market trajectory, and even cryptocurrencies, among other popular global risk assets. If 10-year and longer-term US Treasury yields continue to rise, this means "significantly raising the cost of capital + weakening liquidity expectations + expanding macro denominator" simultaneously for stock markets, cryptocurrencies, and high-yield corporate bonds. The successor to Powell seeks to change your understanding of inflation In addition to cutting the Fed's $6.7 trillion balance sheet, Powell's successor testified before the Senate Banking Committee stating that he wants to change the Fed's and global central banks' economic definition of "inflation." Since January 2012, the Federal Open Market Committee has maintained a 2% long-term inflation target as a strict monetary policy objective. But according to Wash, "price stability should be a dynamic state of price changes, to the point where nobody talks about it." This idea seems to suggest a desire to abandon the strict inflation target and adopt a significantly more vague definition of price changes, giving the Fed's monetary policy greater flexibility in adjusting its stance or taking action. While this may sound beneficial on paper, it poses significant risks of disrupting Wall Street's strong bull market, with some institutional investors even concerned that Wash's actions are aimed at advancing President Trump's "easing plan" in the current high inflation environment. Since the start of the Iran war on February 28th, energy prices have surged. The closure of the Strait of Hormuz has led to the largest energy supply disruption in modern history, driving a decisive rise in inflation over the past 12 months. Undoubtedly, US consumers and businesses are currently facing inflation pressures. If Wash successfully changes the way the FOMC weighs inflation, then the price pressures brought about by the Iran war may quickly prompt more FOMC members to shift towards a neutral or hawkish stance. While the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite continue to perform well amid rapidly rising inflation, a decisive shift by Wash-led Fed could quickly change the tone of the stock market on Wall Street. Wash has proposed that price stability should be a state where "no one discusses price changes." This implies that he may not just mechanically target the 2% point, but pay more attention to whether inflation is already factored into the public, corporate pricing, wage negotiations, and financial market expectations. While this provides greater flexibility in policy, recent statements from Wall Street giants like JPMorgan Chase indicate that in the current context of rising energy prices due to the Iran war and US inflation resurgence, this framework may lead the currently hawkish FOMC to shift more quickly towards a "hawkish stance." As Fed Chairman, Wash has only one vote compared to many hawkish members, so influencing a change in the FOMC's stance will be challenging. The Chairman of the Federal Reserve has significant influence, able to lead the agenda, shape communication frameworks, and set market expectations. However, within the FOMC's voting mechanism, he is essentially just one of the voting members. If a majority of the committee believes that inflation pressures do not allow for rate cuts, Wash will find it difficult to unilaterally push for a dovish path. In the context of oil price shocks and a resurgence of inflation, even if Wash faces political pressure to cut rates, internal hawkish consensus within the FOMC might compel the Fed to maintain higher rates for longer, or even reopen the risk of rate hikes. As Chairman, Wash has significant agenda-setting and communication powers, but he cannot bypass the majority opinion of the committee. The US bond market braces for the 5% era, internal Federal Reserve rifts over balance sheet reduction For the financial markets, the most important question is not whether Wash personally "wants rate cuts", but whether the bond market believes he can maintain the Fed's credibility in the face of inflation. If Wash sends dovish signals too early in a high-inflation environment, long-term US Treasuries could punish policy shifts by decoupling from inflation expectations and raising term premiums, pushing the 10-year yield closer to or testing 5%. The higher the oil price and the more difficult it is to lower inflation, the more investors will demand higher compensation; and a rise in the 10-year yield will increase mortgage rates, corporate debt, leveraged loans, and stock valuation discount rates, directly suppressing overvalued US stocks and the AI capital expenditure narrative. Wash's deeper policy preference is to normalize the Fed's balance sheet. He has long criticized the large-scale bond purchases during the crisis, which led to an oversized Fed balance sheet and may distort market prices; the Fed's current asset size is around $6.7 trillion, still far above pre-financial crisis levels. The issue is that balance sheet reduction is not technologically neutral: reducing holdings of US Treasuries and MBS by the Fed means removing an important marginal buyer, increasing the duration supply the market needs to absorb, depressing bond prices, raising long-term yields, and potentially steepening the yield curve. Fed Governor Bostic openly opposes reducing the Fed's asset size by lowering bank liquidity rules, stating that "shrinking the balance sheet is a wrong target", and many related proposals would weaken bank resilience, hamper money market operations, and threaten financial stability; he also emphasizes that the lesson from the banking stress events in 2023 is not to lower liquidity requirements, but to increase liquidity requirements. All of this suggests that Wash is likely to face two fronts after taking office: an external market front, where investors demand he demonstrates the Fed's independence between inflation and political pressures; and an internal institutional front, where Fed governors, regional Fed presidents, and regulatory officials express skepticism about aggressive balance sheet reduction. New York Fed President Williams, Governor Waller, and others have previously expressed skepticism about returning to the "scarce reserve" framework, indicating that internal Fed support is not unanimous for reducing the balance sheet through lowering reserves and weakening liquidity requirements. This implies that Wash must first establish internal consensus within the FOMC to advance balance sheet reform. If consensus building is slow, the policy path may present a combination of "steady rates, cautious balance sheet reduction, and continued trading risks of rising long-term yields".