2026: The Year of Regime Change at the Federal Reserve

Original author: Alex Krüger

Original translation by: 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 appointment as the new Fed chairman.

Hassett has emerged as Trump's top choice to lead the Federal Reserve (Polymarket rates it at 71%). Currently serving as director of the National Economic Council, he is a supply-side economist and a long-time staunch supporter of Trump's "growth first" philosophy. 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 Fed would move away from the technocratic caution of the Powell era and towards 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 this year regarding interest rates and the Federal Reserve:

• "The only explanation for the Fed not cutting rates in December is partisan bias against Trump." (November 21).
• "If I were on the FOMC, I would be more likely to cut interest rates, while Powell is less likely to do so" (November 12).
• "I agree with Trump that interest rates can be much lower" (November 12).
• "The anticipated three rate cuts are just the beginning" (October 17).
• "I hope the Federal Reserve will continue to cut interest rates significantly" (October 2).
• "The Fed's rate cut is the right step toward significantly lowering interest rates." (September 18).
• "Woller and Trump are right about interest rates" (June 23).

Based on a 1-10 scale of doves to hawks (1 = most dove, 10 = most hawk), Hassett scored 2.

If nominated, Hassett will succeed Milan as a Federal Reserve governor in January, at which point Milan's short term will expire. 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 to pave 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, implying that the Fed's maintenance of restrictive interest rates is a policy mistake.

New balance of power

This structure would 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 would depend on consensus.

• The core of the dove faction (4 people): Hassett (Chairman), Walsh (Director), Waller (Director), and Bowman (Director).
• "Potential centrists" (6 people): Cook (board member), Barr (board member), Jefferson (board member), 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 mentioned above, the market reaction should be divided into four distinct phases:

People were immediately optimistic about Hassett's nomination (in December) and the bullish sentiment in the weeks following his confirmation, as risk assets would love to have a staunch supporter of a high-profile dove sitting on the chairman's seat.

If Powell doesn't announce the board's resignation within three weeks, growing anxiety will ensue, as each additional day of delay raises the question again: "What if he refuses to leave?" Tail risks will resurface.

The moment Powell announced his resignation, it sparked a wave of joy.

With the first FOMC meeting led by Hassett in June 2026 fast approaching, markets are once again on edge, paying close attention to every word of the FOMC voting members (who speak regularly, giving glimpses into their views and thought processes).

Risk: A divided committee

Since the Chair doesn't possess the "clutch vote" many imagine (in reality, no), Hassett must win the debates at the FOMC to secure a true majority. Every 50 basis point change generates a 7-5 split, which is institutionally corrosive, signaling to markets that the Chair is a political manipulator, not an impartial economist. In extreme cases, a 6-6 tie or a 4-8 vote against a rate cut would be disastrous. The exact vote count will be published 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 if Hassett secures four firm votes and has a reliable path to ten, he will reach a dovish consensus and execute his agenda.

Inference: The market cannot fully anticipate the Fed's new round of dovish stances.

Interest Rate Repricing

The dot plot is a misleading indicator. While the September dot plot projected a 3.4% interest rate for December 2026, this figure represents the median across all participants, including hawkish but non-voting participants. By anonymizing the dot plot based on publicly available statements, I estimate the median voter turnout to be significantly lower, at 3.1%.

When I replaced Powell and Milan with Hassett and Warsh, the situation changed further. If Milan and Waller represent the new Fed's aggressive rate-cutting stance, the voting distribution in 2026 remains bimodal, but with a lower peak: Williams/Paulson/Barr at 3.1%, and Hassett/Warsh/Waller at 2.6%. I anchored the new leadership's rate at 2.6%, consistent with Milan's official projections. However, I noted that he had indicated a preference for an "appropriate rate" of 2.0% to 2.5%, suggesting that 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 the market generally expects, which would prompt even larger rate cuts to prevent passive tightening.

Cross-asset impact

While the initial reaction to Hassett's nomination should be "rising risk appetite," the exact manifestation of this regime change is "steepening inflation," which means betting on aggressive easing policies in the short term, but expecting higher nominal growth (and inflation risks) in the long term.

Interest Rates: Hassett wants the Federal Reserve to take aggressive rate cuts during a recession while maintaining growth rates above 3% during periods of economic prosperity. If he succeeds, the 2-year Treasury yield should fall sharply to reflect expectations 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 drastically reduce 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 triggered by negative news. This is 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: "Tealbook"

The Blue Book is the official economic projections of the Federal Reserve staff and the statistical benchmark discussed by all members of the Federal Open Market Committee (FOMC). The report is produced by the Research and Statistics Division, headed by Director Tuffling, which has over 400 economists. Tuffling, like most of her staff, is a Keynesian, and the Fed's main model (FRB/US) explicitly adopts neo-Keynesianism.

Hassett could appoint a supply-side economist to lead the department through a council vote. Replacing a traditional Keynesian economist (who believes economic growth leads to inflation) with a supply-side economist who believes the AI boom will cause deflation would significantly alter forecasts. For example, if the department's models predict inflation will fall from 2.5% to 1.8% due to increased productivity, less dovish Federal Open Market Committee (FOMC) members might be more willing to vote for a significant rate cut.