2026: The Year of Regime Change at the Federal Reserve

ArticleAuthor:Alex KrügerArticle Compilation：Block unicorn

Foreword

The Federal Reserve as we know it will end in 2026.

The most important driver of asset returns next year will be the new Federal Reserve, especially the regime change brought about by Trump's new appointment as Federal Reserve Chairman.

Hassett has become Trump's top choice to lead the Federal Reserve (Polymarket's probability is 71%).

Hassett has become Trump's top choice to lead the Federal Reserve (Polymarket's probability is 71%).

Currently serving as Director of the National Economic Council, he is a supply-side economist and a long-time staunch supporter of Trump, advocating for a "growth first" approach. He believes that maintaining high real interest rates is political obstinacy rather than economic prudence, given the near-victory in the fight against inflation. His potential appointment would mark a decisive shift in administration: the Federal Reserve would shed the technocratic caution of the Powell era and embark on a new mission that explicitly prioritizes lowering borrowing costs to advance the president's economic agenda. To understand the policy framework he will implement, let's accurately assess his comments on interest rates and the Federal Reserve this year: "The only explanation for the Fed not cutting rates in December is anti-Trump partisan bias." (November 21). "If I were on the FOMC, I would be more likely to cut rates, while Powell would be less likely." (November 12). "I agree with Trump that interest rates can be much lower" (November 12). "The expected three rate cuts are just the beginning" (October 17). "I hope the Fed continues to cut rates significantly" (October 2). "The Fed's rate cuts are the right direction towards significantly lower interest rates" (September 18). "Woller and Trump are right about interest rates" (June 23). Using a 1-10 dovish to hawkish rating scale (1 = most dovish, 10 = most hawkish), Hassett scored 2. If nominated, Hassett will succeed Milan as a Federal Reserve Governor in January, when Milan's short-term term will end. Then, in May, when Powell's term ends, Hassett will be promoted to Chairman. Historically, Powell has announced his intentions months in advance and resigned from his remaining governorship, paving the way for Trump's nomination of Warsh to fill the position. While Warsh is currently Hassett's main rival for the chairmanship nomination, my core assumption is that he will be brought into the change camp. As a former Federal Reserve Governor, Warsh has been "campaigning" on a platform of structural reform, explicitly calling for a "new Treasury-Fed deal" and attacking the Fed leadership for succumbing to the "tyranny of the status quo." Crucially, Warsh argues that the current AI-driven productivity boom is essentially deflationary, meaning that the Fed's maintenance of restrictive interest rates is a policy mistake. A new balance of power. This structure will give Trump's Federal Reserve a strong dovish core and credible voting influence on most easing decisions, although this is not a done deal and the degree of dovish tilt will depend on consensus. The core of the dovish core (4 people): Hassett (Chairman), Warsh (Governor), Waller (Governor), Bowman (Governor). Potential centrists (6 people): Cook (Governor), Barr (Governor), Jefferson (Governor), Kashkari (Minneapolis), Williams (New York), A. Paulson (Philadelphia). Hawks (2 people): Hammark (Cleveland), Logan (Dallas). However, if Powell does not resign from his board seat (which is highly likely; historically, all former chairs have resigned, such as Yellen, who resigned 18 days after Powell's nomination), it would be extremely negative. This move would not only block the vacancy Walsh needed, but would also make Powell a "shadow chairman" and create another, potentially more loyal, power center outside the dovish core.

Timeline: Four Stages of Market Reaction

Considering all the factors above, the market reaction should be divided into four distinct stages:

People immediately became optimistic about Hassett's nomination (December) and the bullish sentiment in the weeks following confirmation, as risk assets would love to have a staunch dovish supporter in the chairman's seat.

If Powell does not announce the board's resignation within three weeks, people will become increasingly uneasy, because with each additional day of delay, the question of "What if he refuses to leave?" will resurface. Tail risks will then resurface.

The moment Powell announced his resignation, a wave of jubilation swept through the market. With the first FOMC meeting under Hassett's leadership approaching in June 2026, markets are once again on edge, scrutinizing every word from the FOMC voting members (who speak regularly, offering glimpses into their views and thought processes). Risk: A Divided Committee. Since the chair doesn't possess the "decisive vote" many imagine (in reality, no), Hassett must win the debates within the FOMC to secure a true majority. Every 50 basis point change would result in a 7-5 split, which would be corrosive institutionally, signaling to the market that the chair is a political manipulator, not an impartial economist. In extreme cases, a 6-6 tie or a 4-8 vote against rate cuts would be disastrous. The exact vote count will be released in the FOMC meeting minutes three weeks after each meeting, turning this information into a major market-moving event. The biggest unknown is what happens after the first meeting. My base case is that Hassett, if he secures four firm votes and has a credible path to ten, will achieve a dovish consensus and execute his agenda. Inference: The market cannot fully anticipate a new round of dovish stance from the Fed. Interest Rate Repricing: The dot plot is merely an illusion. Although the September dot plot projected a 3.4% interest rate for December 2026, this figure represents the median across all participants, including those hawkish but non-voting participants. By anonymizing the dot plot based on public statements, I estimate the median voter turnout to be significantly lower, at 3.1%. The picture changes further when I replace Powell and Milan with Hassett and Warsh. If Milan and Waller represent the new Fed's aggressive rate-cutting stance, the 2026 vote distribution remains bimodal, but with a lower peak: Williams/Paulson/Barr at 3.1%, and Hassett/Warsh/Waller at 2.6%. I anchor the new leadership's rate at 2.6%, consistent with Milan's official projections. However, I note he has indicated a preference for an "appropriate rate" of 2.0% to 2.5%, suggesting the new mechanism's inclination is even lower than they predicted. The market has partially recognized this, with interest rate expectations for December 2026 at 3.02% as of December 2nd, but it has not yet fully priced in the magnitude of this regime change. If Hassett successfully guides interest rate cuts, the short-term yield curve will need to decline by another 40 basis points. Furthermore, if Hassett's predictions of supply-side deflation are correct, inflation will decline faster than generally expected, prompting even larger rate cuts to prevent passive tightening. Cross-Asset Impact: While the initial reaction to Hassett's nomination should be one of "increased risk appetite," the precise manifestation of this regime change is "steepening inflation"—betting on aggressive easing in the short term, but expecting higher nominal growth (and inflation risk) in the long term. Interest Rates: Hassett wants the Federal Reserve to take aggressive rate cuts during a recession while maintaining growth above 3% during boom times. If he succeeds, the 2-year Treasury yield should fall sharply to reflect the expectation of rate cuts, while the 10-year Treasury yield is likely to remain high due to higher structural growth and a persistent inflation premium. Equities: Hassett believes the current policy stance is actively suppressing the AI-driven productivity boom. He will significantly lower the real discount rate, thereby driving a "surge" in the valuation multiples of growth stocks. The danger is not an economic recession, but rather the bond market turmoil triggered by the surge in long-term yields due to protests. Gold: A politically aligned Federal Reserve that explicitly prioritizes economic growth over inflation targets is undoubtedly a textbook bullish scenario for hard assets. Gold should outperform US Treasuries as the market hedges against the risk of a new administration repeating the policy mistakes of the 1970s through excessive interest rate cuts. Bitcoin: Under normal circumstances, Bitcoin would be the purest embodiment of a "regime change" trading strategy. However, since the October 10th shock, Bitcoin has exhibited a severe downward skew, with a weak macroeconomic rebound and sharp drops on negative news, primarily due to heightened market concerns about the "four-year cycle" and a crisis in Bitcoin's own positioning. I believe that by 2026, Hassett's monetary policy and Trump's deregulation agenda will overcome the currently dominant self-fulfilling bearish sentiment. Technical Explanation: The "Tealbook" The Tealbook is the official economic projections of the Federal Reserve staff and the statistical benchmark discussed by all Federal Open Market Committee (FOMC) members. This report is produced by the Research and Statistics Division, headed by Director Tefling, which has over 400 economists. Tefling, like most of her staff, is a Keynesian, and the Fed's main model (FRB/US) explicitly adopts neo-Keynesianism. Hassett can appoint a supply-side economist to lead the division through a vote by the Board. Replacing a traditional Keynesian economist (who believes economic growth leads to inflation) with a supply-side economist (who believes the AI ​​boom will lead to deflation) would significantly alter the projections. For example, if the department's models predict that inflation will fall from 2.5% to 1.8% due to increased productivity, then less dovish Federal Open Market Committee (FOMC) members might be more willing to vote for a significant interest rate cut.