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[Balance Sheet Reduction Is Not a Panacea: Deutsche Bank Warns of Japan's Mistake] ⑴ Deutsche Bank strategists questioned Federal Reserve Chairman Warsh's proposed balance sheet reduction approach, arguing that simply reducing bond holdings may not tighten financial conditions as expected and could potentially repeat Japan's mistakes. ⑵ The Bank of Japan implemented a more aggressive quantitative tightening program, allowing a large amount of government bonds to remain unrenewed upon maturity. Its balance sheet reduction pace was the most aggressive among G10 economies. However, the yen has been deeply mired in depreciation since 2012, proving that balance sheet reduction itself does not necessarily support the exchange rate. ⑶ Deutsche Bank's Head of Foreign Exchange Research, Saravilos, pointed out that for balance sheet reduction to produce a positive monetary effect, it must be accompanied by a substantial rise in short-term government bond yields. Relying solely on the natural maturity of medium- and long-term bonds will significantly diminish the effect. (4) A greater contradiction lies in the fact that Warsh's determination to push for balance sheet reduction is likely to directly conflict with the Trump administration's policy demand to maintain low interest rates. With the fiscal deficit consistently exceeding 6% of GDP, artificially lowering interest rates to control interest payments may become an unavoidable choice, which directly contradicts Warsh's tightening direction. (5) Saravelos also believes that the Fed's current holdings of US Treasury bonds are not excessive, and the actual effectiveness of balance sheet reduction in curbing inflation may be overestimated. If Warsh insists on using this as the main policy line, Deutsche Bank sees it as a structurally negative signal for the dollar. (6) Japan's experience shows that an excessively rapid pace of balance sheet reduction may exacerbate economic vulnerability. Ultimately, exchange rate movements depend on the shape of the yield curve and the coordination of fiscal policy, rather than simply changes in asset size. Whether Warsh's balance sheet reduction agenda can gain the cooperation of the executive branch remains uncertain. (7) The market's focus will shift to the degree of disagreement within the Fed regarding the pace of balance sheet reduction, and whether the connection between the Treasury's bond issuance plan and the central bank's operations is smooth. These factors will jointly determine the underlying logic of the dollar's medium-term trend.