The debate surrounding Donald Trump's potential pick for the next Federal Reserve Chair has largely centered on whether his chosen candidate would aggressively cut interest rates as he desires. However, with the former president now considering ex-Fed Governor Kevin Warsh—an economist notorious for his sharp critiques of the central bank and his monetary policy views—the discussion has abruptly pivoted from short-term rates to the Fed's colossal $6.6 trillion balance sheet.
Warsh has publicly lambasted his former colleagues for years, accusing them of allowing bank assets to swell, which has fueled market speculation that he might act swiftly to shrink the asset portfolio. Such rumors drove up long-term U.S. Treasury yields last Friday, strengthened the dollar, and triggered a sharp decline in gold and silver prices. Zach Griffiths, Head of Investment Grade and Macro Strategy at CreditSights, noted, "He has been very critical of the Fed's balance sheet expansion."
Warsh's views on excessive Fed intervention align with those of Treasury Secretary Scott Bessent, indicating a desire to reverse the trend aggressively and push for other reforms. Yet, this endeavor is far from simple, as it would not only directly impact long-term interest rates but also affect the world's largest and most crucial financial lending market. Based on market movements, under Warsh's leadership, any Fed-approved measures to reduce the balance sheet could potentially run counter to the goal of lowering long-term borrowing costs.
This might compel the U.S. Treasury or other American institutions to take a more active role in market management—a task growing increasingly difficult as total borrowing demand continues to rise and the national debt surpasses $30 trillion. As early as January, Trump directed government-controlled entities Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities to help control costs for potential homebuyers.
Greg Peters, Co-Chief Investment Officer of PGIM Fixed Income and a member of the Treasury Borrowing Advisory Committee, stated, "If you take Warsh at his word, that he dislikes compressing yields via balance sheet expansion, then that implies the onus falls on the Treasury." This committee comprises dealers, investors, and other market participants.
Conversely, Warsh might argue that by tightening financial conditions through balance sheet reduction, the Fed would create room to lower the benchmark interest rate further. Fed Governor Stephen Milan (a Trump appointee) said in an interview last Friday, "In theory, if you adhere to the principle of minimal Fed intervention in the economy and wish to shrink the balance sheet, you could offset your balance sheet operations by adjusting short-term rates. If that causes long-term rates to rise, you can counteract the tightening of financial conditions by cutting short-term rates."
During his tenure as a Fed Governor from 2006 to 2011, Warsh was initially a supporter of the Fed's bond-buying program, known as Quantitative Easing (QE). However, over time, he grew increasingly vocal in his criticism of the practice and ultimately resigned over the Fed's decision to continue bond purchases. Starting with emergency measures after the global financial crisis and continuing through the COVID-19 pandemic, the Fed amassed vast holdings of U.S. Treasuries and other debt to support the economy by maintaining market stability and controlling borrowing costs.
Warsh has argued in speeches and interviews that the aggressive bond-buying policy was an overcorrection, artificially suppressing borrowing rates for too long. This, in turn, encouraged risk-taking on Wall Street and prompted U.S. lawmakers to increase debt, ultimately leading to what he terms "monetary dominance"—a situation where financial markets become excessively reliant on central bank support.
His proposed solution, mentioned in a July interview, is straightforward: "Print less money, let the balance sheet shrink, let Secretary Bessent handle the fiscal accounts, and then interest rates can come down significantly." In another interview that same month, he referenced the landmark 1951 Treasury-Fed Accord, which established central bank independence, and suggested a need to redefine that relationship.
Warsh stated, "We need a new Treasury-Fed accord, akin to 1951. At that time, with our national debt climbing and the central bank and Treasury operating at cross-purposes, we had to accept such an agreement." Under a new accord, he said, "the Fed Chair and the Treasury Secretary could clearly and prudently explain to the market: 'This is our target for the size of the Fed's balance sheet.'"
Shrinking the Fed's balance sheet is no easy task. If Warsh's nomination is confirmed, he would face a balance sheet several orders of magnitude larger than during his previous tenure. Money markets are particularly sensitive to minor changes in system liquidity, as evidenced in 2019 when the Fed had to intervene to ease funding strains that caused a spike in short-term lending rates.
More recently, towards the end of 2025, increased U.S. government borrowing, coupled with the Fed's ongoing reduction of some assets—a process known as Quantitative Tightening (QT)—led to diminished cash in money markets, creating a smaller but still noticeable tightening. Shortly thereafter, the Fed abruptly halted QT and began reinvesting by purchasing short-term Treasuries maturing within one year to replenish system reserves.
In December, the Fed started buying approximately $40 billion in Treasuries per month to alleviate pressure from rising short-term rates. Joseph Abate, U.S. Rate Strategist at SMBC Nikko Securities America, wrote in a client note on Friday, "As funding stresses last autumn showed, the demand for bank reserves depends on banks' regulatory and internal liquidity needs."
For nearly two decades following the financial crisis, policymakers adopted an "ample" reserves framework. This framework aims to ensure sufficient cash circulates within the banking system, enabling lenders to meet regulatory liquidity requirements and settle payments without borrowing from the Fed. A return to a scarce reserves environment could lead to bank overdrafts, increased borrowing, and heightened volatility in the Fed's balance sheet size.
Barclays strategists Samuel Earl and Demi Hu suggest there is "some wiggle room" within the Fed's definition of "ample." For a potential chair like Warsh aiming to shrink the balance sheet, officials could halt monthly Treasury purchases, allowing funding costs to rise, potentially even above the Fed's target range for the federal funds rate.
Barclays posits another option: adjusting the composition of the Fed's Treasury portfolio to favor shorter-term securities that better match its liabilities, rather than long-term debt. Currently, the weighted average maturity of the Fed's balance sheet assets exceeds nine years, while its liabilities (including the Treasury General Account, reserves, and foreign exchange) have an average maturity of about six years.
Given that Chair Warsh would hold only one vote on the Federal Open Market Committee (FOMC), the extent to which he could implement broad policy changes remains uncertain. Analysts at JPMorgan Chase & Co. wrote in a report on Friday that Warsh would need to build consensus; while some committee members share his concerns, many still support maintaining an ample reserves regime.
Vail Hartman, an analyst at BMO Capital Markets, believes the Fed's ample reserves framework is unlikely to see a policy shift in the near term. However, he noted in a report last Friday that adding another "balance sheet hawk" to the FOMC should help curb future asset purchases or reinvestment policies. Hartman also wrote that "significantly reducing the balance sheet size would likely require major adjustments to the Fed's existing bank regulatory framework."
Nevertheless, traders are already on alert. Gennadiy Goldberg, U.S. Rates Strategist at TD Securities, said, "For now, the status quo holds, but markets will remain nervous until Warsh clarifies his stance."
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