Warsh's return revives tensions over US Fed's $6.6 trn QE hangover

For much of the time that President Donald Trump was mulling his potential choice for the next chair of the Federal Reserve, the debate in markets swirled around whether his pick would lower interest rates as aggressively as he preferred. 

 

Now, with his selection of former Fed Governor Kevin Warsh — an economist known as much for his fierce criticism of the central bank as his views on monetary policy — the debate has abruptly shifted from short-term rates to the Fed’s $6.6 trillion balance sheet and its very role in markets.

 

Warsh has repeatedly and loudly blasted his old colleagues over the years for letting the bank’s assets balloon, prompting speculation in markets that he could move quickly to have them drawn down. That chatter helped push yields on longer-term Treasuries higher on Friday, as the dollar got a lift and gold and silver plunged.

 

 

“He’s been very critical of the Fed’s balance sheet expansion,” said Zach Griffiths, head of investment-grade and macro strategy at CreditSights.

 

Warsh, whose views on Fed overreach align with those of US Treasury Secretary Scott Bessent, would like to definitively reverse this trend and push for other reforms. But doing so would be tricky, with direct consequences not just for long-term rates, but for major markets that are crucial for how the world’s largest financial institutions borrow and lend to each other for day-to-day activities.

 

Depending on how it plays out in markets, a Fed pullback — if approved by policymakers — might also leave a Warsh-led central bank working against the administration’s aim of lower long-term borrowing costs. That could put pressure on the Treasury or other US entities to get more involved with market management, something that’s also all the more challenging as total borrowing needs continue to rise, and with the national debt well past $30 trillion as it is.

 

Already, Trump in January directed government-controlled Fannie Mae and Freddie Mac to buy $200 billion of mortgage-backed securities to help cap costs for would-be homebuyers. 

 

“If you take Warsh at his word that he dislikes balance sheet expansion as a way to compress yields, then it means it falls onto Treasury,” said Greg Peters, co-chief investment officer at PGIM Fixed Income and a member of the Treasury Borrowing Advisory Committee, a panel made up of dealers, investors and other market participants. 

 

At the same time, Warsh could argue that by tightening financial conditions, a smaller balance sheet would grant his Fed room to cut its benchmark rate deeper.

 

“In theory, you can be moving the short rate around to offset whatever you’re doing on the balance sheet, if you want to shrink the balance sheet because you have a principle that you want the Fed to have a minimal footprint in the economy,” Fed Governor Stephen Miran, a Trump appointee, told Bloomberg Television on Friday. “Then if that were to cause an increase in long rates you can offset that tightening of financial conditions by reducing the short rate.”

 

Warsh was an initial proponent of the Fed’s bond-buying campaign, known as quantitative easing, or QE, during his tenure at the central bank from 2006 to 2011, but he became an increasingly vocal critic of the practice as time went on and ultimately tendered his resignation over the central bank’s continued purchases.

 

Beginning with emergency efforts after the global financial crisis and continuing through the Covid-19 pandemic, the central bank accumulated a mountainous portfolio of US Treasuries and other debt in its efforts to support the economy by keeping markets stable and containing borrowing costs. 

 

‘Monetary Dominance’

 

In speeches and interviews, Warsh has argued that the aggressive bond buying went too far and artificially depressed borrowing rates for extended periods. That, in turn, fanned Wall Street risk-taking while encouraging US lawmakers to pile on more debt, leading to what he called “monetary dominance,” in which financial markets become overly dependent on central-bank support.

 

His remedy, conveyed in an interview on Fox Business in July: “My simple version of this is: Run the printing press a little bit less. Let the balance sheet come down. Let Secretary Bessent handle the fiscal accounts, and in so doing, you can have materially lower interest rates.” 

 

In an interview with CNBC the same month, he invoked the landmark 1951 Treasury-Fed accord that established central bank independence, saying the relationship needed to be redefined.

 

“We need a new Treasury-Fed accord, like we did in 1951 after another period where we built up our nation’s debt and we were stuck with a central bank that was working at cross purposes with the Treasury,” Warsh said. Under such a new accord, he said, “the Fed chair and the Treasury secretary can describe to markets plainly and with deliberation, ‘This is our objective for the size of the Fed’s balance sheet.’”

 

Shrinking the Fed’s footprint won’t be easy. Should he be confirmed, Warsh would face a balance sheet that’s orders of magnitude greater than when he was last at the central bank.

 

Money markets in particular have proved sensitive to even the slightest changes in the amount of liquidity in the system. A prime case was in 2019, when the Fed had to step in to ease funding strains that sent short-term lending rates skyrocketing. 

 

More recently at the end of 2025, an increase in government borrowing, combined with the Fed’s ongoing unwind of some of its holdings — a process known as quantitative tightening — caused a smaller but still notable squeeze by siphoning cash out of money markets.

 

Shortly after, the Fed abruptly stopped QT and pivoted to adding reserves back into the financial system by buying short-term Treasuries due in less than a year. The Fed in December began buying about $40 billion of bills each month in a bid to ease the pressures that were building in short-term rates.

 

“As last fall’s funding pressure illustrated, the demand for bank reserves - and, as a result, the size of the Fed’s balance sheet - is determined by banks’ regulatory and internal liquidity needs,” Joseph Abate, head of US rates strategy at SMBC Nikko Securities America, wrote in a note to clients Friday. 

 

In the decades after the financial crisis, policymakers adopted an “ample” reserves framework. This was designed to keep enough cash flowing through the banking system so that lenders are able to satisfy liquidity requirements mandated by regulations and settle payment flows without needing to borrow from the Fed. A return to an environment where reserves are scarce could result in banks’ overdrawing their accounts, and in turn increased borrowing and gyrations in the size of the Fed’s balance sheet. 

 

Wiggle Room

 

Barclays strategists Samuel Earl and Demi Hu argued that there’s “a bit of wiggle room” within the Fed definition of ample. For a potential Fed chair like Warsh who is aiming for a smaller balance sheet, officials could stop monthly purchases of Treasury bills and allow funding costs to drift higher, possibly outside the Fed’s target range for the federal funds rate.

 

The other option is to adjust the composition of the Fed’s Treasuries portfolio so their holdings are skewed toward shorter-maturity securities that better match their liabilities instead of longer-term debt, according to Barclays. The weighted average maturity of the balance sheet is currently more than nine years, whereas the average maturity of its liabilities — Treasury General Account, reserves, currency — is around six years. 

 

It remains to be seen how much scope Warsh will have to implement expansive policy changes given that the chair is still just one vote on the Federal Open Market Committee. Warsh would need to build consensus, and while some members share his concerns, many still support maintaining an ample-reserves regime, wrote analysts at JPMorgan Chase & Co. in a note Friday.

 

For BMO Capital Markets’ Vail Hartman, the Fed’s adoption of the ample-reserves framework makes it difficult to imagine a near-time pivot, but the addition of another “balance-sheet hawk” on the FOMC should help keep a check on future asset purchases or reinvestment policies, he wrote on Friday. Beyond that, “a significantly smaller balance sheet would likely require a major shift in the Fed’s existing bank regulatory framework,” Hartman wrote.

 

Even so, traders consider themselves on notice.

 

“For now it’s status quo, but markets will remain on edge until Warsh makes his views clearer,” said Gennadiy Goldberg, head of US rates strategy at TD Securities.