For much of the time President Trump has been considering his next Fed chair nominee, the market debate has centered on whether his pick for Powell's successor would deliver the substantial interest rate cuts he desires. However, with Trump's formal nomination of former Fed Governor Kevin Warsh—an economist renowned for his severe criticism of the central bank and his distinct monetary policy views—the debate has abruptly shifted from the path of short-term rates to the Fed's $6.6 trillion balance sheet and its central role in the markets. Note: The Fed's balance sheet. Warsh has repeatedly publicly criticized Fed officials for allowing the central bank's assets to balloon over the years, sparking market speculation that he might move swiftly to reduce the balance sheet if appointed. This speculation and expectation pushed long-term Treasury yields higher last Friday, while also causing a significant rebound in the U.S. dollar and a sharp decline in gold and silver prices. As Zach Griffiths, Head of Investment Grade and Macro Strategy at CreditSights, stated, "He (Warsh) has been very critical of the expansion of the Fed's balance sheet." So, if Warsh successfully takes over the Fed chairmanship from Powell this summer, how might he actually implement his policy views? How might the division of responsibilities between the Fed and the U.S. government (primarily the Treasury), and the direction of U.S. long-term interest rates, change? First, Warsh's views on some of the Fed's overreach align with those of U.S. Treasury Secretary Scott Bessent; he aims to completely reverse this trend and push for other reforms. But this move is also destined to face a tricky situation—its direct impact involves not only long-term interest rates but also the key markets upon which the daily lending activities of major global financial institutions rely. To a large extent, if Fed policymakers approve policies for further balance sheet reduction, the market impact could lead a Warsh-led Fed to work at cross-purposes with the government's goal of lowering long-term borrowing costs. This would force U.S. institutions like the Treasury to increase market intervention—a task that will become even more challenging as total government borrowing needs continue to rise and the scale of U.S. national debt has surpassed $30 trillion. It is worth mentioning that in January, Trump directed the government-controlled Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities (MBS) to help control costs for potential homebuyers, which has already, to some extent, been "sharing" the central bank's role. Greg Peters, Co-Chief Investment Officer at PGIM Fixed Income and a member of the U.S. Treasury Borrowing Advisory Committee, pointed out, "If Warsh insists on opposing yield suppression via balance sheet expansion, it implies the U.S. Treasury will bear more responsibility." In an interview last year, Warsh cited the 1951 Treasury-Fed Accord, which established central bank independence, to advocate for redefining the relationship between the two entities. Warsh stated, "We need a new Treasury-Fed Accord, like in 1951—when after national debt accumulation, we found ourselves in a situation where the central bank and Treasury objectives were in conflict." He emphasized that under a new framework, "The Fed Chair and the Treasury Secretary could clearly and prudently communicate to the market: 'This is our target for the size of the Fed's balance sheet.'" Meanwhile, regarding monetary policy trade-offs, Warsh might also argue that by tightening financial conditions, shrinking the balance sheet would create more room for the Fed to cut benchmark interest rates more significantly. "In theory, if the Fed reduces its balance sheet based on the principle of minimizing intervention in the economy, it could offset the impact of balance sheet operations by adjusting short-term rates," said Trump-appointed Fed Governor Christopher Waller last Friday. "If this (balance sheet reduction) leads to higher long-term rates, the tightening of financial conditions could be offset by lowering short-term rates." Looking at his past record, during his tenure at the Fed from 2006 to 2011, Warsh was an early advocate of the Fed's quantitative easing (QE)—the bond-buying program. However, over time, he gradually became a fierce critic of the policy, eventually resigning due to the Fed's continued bond purchases. From the emergency actions following the global financial crisis, continuing through the COVID-19 pandemic, the Fed accumulated a massive amount of U.S. Treasuries and other debt in its efforts to support the economy, stabilize markets, and control borrowing costs. Warsh has repeatedly pointed out in recent speeches and interviews that the aggressive bond-buying policy went too far, artificially suppressing long-term borrowing rates. This, in turn, fueled risk-taking on Wall Street while encouraging U.S. lawmakers to continually increase debt, leading to what he calls "monetary dominance"—excessive market reliance on central bank support. He proposed a solution in a July interview last year: "My simplified version is: Print less money. Let the balance sheet shrink. Let Treasury Secretary Bessent handle the fiscal account, enabling a substantial decline in interest rates." Trump's chief economic adviser, Kevin Hassett, also said on Sunday that the Fed should focus on making its balance sheet "as lean as possible." Hassett called Trump's Fed chair nominee, Kevin Warsh, "the right person at the right time." The Fed should focus on its mandates: maintaining financial stability, lowering interest rates, reducing unemployment, and curbing inflation. The Fed should do this in an "old-fashioned, quiet way." Of course, shrinking the Fed's footprint is no easy task. If confirmed, Warsh would face a balance sheet several times larger than when he last served at the central bank. Money markets are particularly sensitive to small changes in the amount of liquidity in the system. The year 2019 serves as a classic case study, when the Fed had to intervene to alleviate funding pressures that caused short-term lending rates to spike. A more recent example was in late 2025, where increased government borrowing combined with the Fed's continued runoff of its asset holdings—i.e., quantitative tightening (QT)—led to a smaller but still significant funding squeeze by draining cash from money markets. Shortly thereafter, the Fed abruptly announced the end of QT and instead began injecting reserves back into the financial system by purchasing Treasury bills maturing in one year or less. The Fed began buying roughly $40 billion per month in Treasury bills last December to ease pressure from rising short-term rates. Joseph Abate, Head of U.S. Rates Strategy at SMBC Nikko Securities America, wrote in a client note last Friday: "As the funding stress last autumn showed, the demand for bank reserves—and thus the size of the Fed's balance sheet—is determined by banks' regulatory and internal liquidity needs." In the decades following the financial crisis, Fed policymakers adopted an "ample reserves" framework—aimed at keeping enough cash circulating in the banking system so that lenders can meet regulatory liquidity requirements and settle payment flows without needing to borrow from the Fed. A return to a scarce reserves environment could lead to banks overdrawing their accounts, increasing borrowing, and causing fluctuations in the size of the Fed's balance sheet. Barclays strategists Samuel Earl and Demi Hu suggested there is "some flexibility" in the Fed's definition of when reserves are "ample." Barclays noted that for a Fed chair candidate like Warsh, whose goal is to shrink the balance sheet, officials could stop the monthly Treasury bill purchases and allow funding costs to rise, potentially even above the Fed's target range for the federal funds rate. Another option would be to adjust the composition of the Fed's Treasury portfolio, tilting its holdings towards shorter-dated securities to better match its liabilities, rather than holding long-term debt. Currently, the weighted average duration of the Fed's balance sheet exceeds nine years, while the average maturity of its liabilities (Treasury General Account, reserves, currency in circulation) is about six years. Of course, given that the Fed chair still holds only one vote on the Federal Open Market Committee (FOMC), the extent to which Warsh could implement broad policy changes remains to be seen. JPMorgan Chase & Co. wrote in a report last Friday that Warsh would need to build consensus, and while some members share his concerns, many still support maintaining the ample reserves regime. Vail Hartman of BMO Capital Markets wrote that, having adopted the ample reserves framework, a significant shift is hard to imagine in the short term. However, he believes adding another "balance sheet hawk" to the FOMC would help curb future asset purchase or reinvestment policies. Beyond that, Hartman wrote: "A significant reduction of the balance sheet would likely require a major shift in the Fed's existing bank regulatory framework." As foreign exchange and commodities experienced sharp volatility last Friday, some traders believe they may have already received a warning. Gennadiy Goldberg, Head of U.S. Rates Strategy at TD Securities, stated, "Although policy remains status quo for now, the market will stay on edge until Warsh further clarifies his views."
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