Balance-sheet reduction may not be the panacea Kevin Warsh think it is, says Deutsche Bank strategist
Japan tried what Fed Chair Kevin Warsh is suggesting.
During Wednesday's congressional appearance, new Federal Reserve Chair Kevin Warsh suggested one possible means of tightening monetary policy without resorting to the straightforward rate hikes that might prove unpopular in an election year: reducing the central bank's balance sheet.
Warsh noted in his testimony that "It took us nearly eighteen years to find our way into this balance sheet. We're holding a lot of long-term Treasury debt and mortgage securities." These asset purchases, known more commonly as "quantitative easing," resulted in the Fed's current balance sheet of roughly $7 trillion.
Deutsche Bank head of currency research George Saravelos points out a similar experiment conducted by the Bank of Japan has proven highly detrimental to its currency. In fact, "by allowing a large amount of Japanese government bonds to roll off its balance sheet as they mature, Japan's quantitative tightening pace has been far more aggressive than other G10 economies."
The yen (USDJPY), however, has been in seemingly irreversible decline since 2012, though.
Saravelos opines that balance-sheet tightening isn't currency-bullish unless it comes in conjunction with higher yields at the short end of the Treasury curve.
He also emphasizes that Warsh's commitment to balance-sheet tightening is likely to bring the Fed into conflict with the Trump administration given the latter's repeated objective of keeping rates low.
Saravelos points out that with U.S. fiscal deficits likely to remain above 6% of GDP as far as the eye can see, then financial repression (keeping rates artificially low so the interest expense bill remains manageable) may be necessary. This is the exact opposite of what Warsh intends.
'It's not unusual' - Fed ownership of UST
Saravelos doesn't think the Fed's ownership of U.S. Treasurys is excessive, as it happens. To his mind, the balance-sheet reduction may therefore fail to combat inflation like Warsh thinks it might. If that's the direction in which Warsh is travelling, Saravelos concludes, then Deutsche Bank regard this as bearish for the dollar DXY.
-Jules Rimmer
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(END) Dow Jones Newswires
July 16, 2026 08:37 ET (12:37 GMT)
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