USD Bears Beware: Citadel Predicts Zero Fed Cuts Amid Warsh 'Hawk' Pivot

The narrative of a weakening US Dollar is facing a severe stress test. Citadel Securities economist Nohshad Shah has issued a stark warning to currency markets: the Federal Reserve may hold interest rates steady for the entirely of the coming year, defying consensus for easing.

The core thesis rests on the “unprecedented policy mix” fueling the US economy. With nominal GDP tracking between 5% and 6% and expansive fiscal stimulus on the horizon, the macroeconomic data suggests the Fed has little justification to lower borrowing costs.

The 'Warsh Effect' on Treasury Yields

The nomination of former Fed Governor Kevin Warsh as the next Federal Reserve Chair has injected a new layer of hawkish vigilance into the market. Unlike the incumbent Jerome Powell, Warsh is viewed as a “strict constructionist” on monetary policy, prioritizing price stability over dual-mandate flexibility.

Shah notes that Warshs historical record suggests a low tolerance for expanding the balance sheet (QE). His nomination signals a potential regime shift:

• Rate Path: The neutral rate may be structurally higher; cuts will require clear economic deterioration, not just disinflation.
• Balance Sheet: Warsh is an advocate for “shrinkage first,” viewing the current balance sheet as a distortion of free markets.

Consequently, the US Dollar Index (DXY), which had softened on previous “peak rate” narratives, may find a floor. Shah advises that the risk-reward for shorting the dollar at current valuations is increasingly poor.

The Liquidity Paradox

However, analysts at Mizuho Securities highlight a structural risk in Warshs agenda. While Warsh advocates for aggressive Quantitative Tightening (QT), the banking system's reserve levels are already approaching the “lowest comfortable level” (estimated near $2.9 trillion).

To shrink the balance sheet further without crashing the repo market, the Fed might be forced into a paradoxical intervention: expanding the Standing Repo Facility (SRF). This would effectively mean the Fed provides liquidity via one hand (SRF) while removing it with the other (QT), potentially increasing market volatility rather than dampening it.