Federal Reserve Chair Kevin Warsh has reiterated his preference for reducing the size of the central bank's balance sheet, while emphasizing that any such moves would be implemented only after thorough public communication and preparation.
Speaking at the European Central Bank's Central Banking Forum in Sintra, Portugal, on Wednesday, Warsh stated: "It took us about 18 years to build the balance sheet to the size it is today, in my view, nearly at the boundary of fiscal policy. To bring it back to a reasonable size will certainly take longer than 18 weeks."
Warsh announced last month the formation of a working group to study balance sheet issues. He said on Wednesday that this group would include "external participants," for which he is "open-minded," but he hopes that interest rate policy will remain the Fed's primary tool. He noted that any decisions would be made jointly by the Federal Open Market Committee (FOMC) and the Federal Reserve Board.
Warsh's remarks further reinforce Wall Street's assessment that the Fed may not truly initiate further balance sheet reduction until 2027. During the global financial crisis and the COVID-19 pandemic, the Fed expanded its balance sheet through multiple rounds of asset purchases. Its size peaked at nearly $9 trillion in June 2022, compared to less than $900 billion in 2007.
Strategists like Michael Cloherty at CIBC have long held the view that the Fed's future steps to reduce its balance sheet are likely to be slow and limited in scale. The bank expects the central bank to announce a plan near the end of this year, followed by a public comment period expected to last until the second quarter of 2027, with the Fed beginning balance sheet reduction in the fourth quarter of next year.
Although Warsh has long advocated for a significant reduction in the Fed's role in asset markets, Wall Street strategists widely doubt whether the Fed can truly achieve a substantial shrinkage of its balance sheet.
Many believe the U.S. financial system is structurally dependent on more abundant reserves. Reducing the balance sheet too quickly could disrupt short-term funding markets.
Barclays strategist Samuel Earl stated: "The alternative is that reserves become scarce. The risks associated with reserves trending towards scarcity are much greater than any potential benefits, and could even lead to chaos in the repo market."
Warsh also mentioned on Wednesday that he would "likely announce" the members of the various working groups "next week." In addition to the balance sheet, several other working groups will study issues such as the Fed's data usage, productivity and employment, communication methods, and the inflation framework.
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