The Fed's balance sheet, Kevin Warsh's first battlefield

On rates, Kevin Warsh is a prisoner: of inflation at 4.2%, of the Iranian energy shock, and of his eighteen FOMC colleagues who leave him only one vote. It is elsewhere that he will leave his mark. The 17th chair of the Federal Reserve, in office since 22 May 2026, has made the central bank’s balance sheet the heart of his doctrine. Yet he inherits a paradoxical situation: the committee has just closed the very file he would like to reopen.

Where the balance sheet stands

A reminder of the orders of magnitude. The Fed’s balance sheet went from about $900 billion before 2008 to a peak of $8.97 trillion in April 2022, swollen by the massive pandemic purchases. Since then, the Fed has contracted it through quantitative tightening, by letting a capped amount of securities mature each month without replacing them. As of 3 June 2026, total assets stand at about $6.71 trillion, of which $4.47 trillion of Treasuries and $1.97 trillion of MBS, the mortgage-backed securities.

Two facts frame all the rest. First, over the three and a half years of QT, the Fed has erased only about half of the pandemic expansion. Its share of nominal GDP has fallen from 33% to 20%, but the balance sheet remains more than seven times its pre-2008 level. Second, and this is the essential, this QT is over. On 29 October 2025, under Powell, the FOMC announced the halt of securities reduction as of 1 December. Since then, the Fed reinvests the full principal of maturing Treasuries and shifts the principal of MBS toward Treasury bills. The balance sheet therefore no longer contracts in aggregate.

The reason for this halt is not ideological, it is plumbing. Bank reserves, around $2.89 trillion at the end of 2025, were approaching the threshold below which funding markets seize up, estimated between $2.5 and $2.7 trillion. The memory of September 2019, when the previous slimming cure triggered a spike in repo rates and forced the Fed to re-inject liquidity on an emergency basis, still haunts the committee. The reverse repo facility, that cushion of excess liquidity that exceeded $2.3 trillion at the end of 2022, is today almost empty. In other words, the cushion has melted, and the committee judged there was no margin left to continue without risk.

What Warsh wants

Warsh’s doctrine runs against this status quo. As early as July 2025, on CNBC, he called for a regime change and denounced a credibility deficit among the incumbent leaders. His vision of the balance sheet rests on three points.

First point: substitute active reduction for the mere passive runoff. Where Powell waited for securities to mature, Warsh raised the possibility of selling assets, a faster and more brutal instrument, never used by the Fed in its two QT episodes.

Second point: dismantle the Fed’s status as buyer of last resort in the bond market. Warsh reproaches the central bank for having become a permanent, distorting presence in the Treasury market. He advocates a durable retreat of this footprint.

Third point: explicit coordination with the Treasury. Warsh argued for the Fed chair and Treasury Secretary Scott Bessent to announce a balance-sheet size target to markets together. This idea breaks with the tradition of independence and blurs the border between monetary policy and debt management, which worries some observers.

The balance-sheet trap

Warsh’s problem is that he wants to reopen a door the committee closed for good technical reasons. Relaunching an aggregate balance-sheet contraction, all the more through active sales, would amount to pushing reserves below the stress threshold, with a risk of repeating the 2019 episode. No chair, however hawkish, wishes to inaugurate his term with a liquidity crisis in the most important market in the world.

But the balance sheet also offers Warsh a weapon he does not have on rates. Reducing the balance sheet, or even just slowing its recomposition, tightens financial conditions through the long-rate channel, without touching the policy rate. It is a disguised tightening. For a chair caught between an inflation he judges he must fight and a US president who demands rate cuts, it is precious room for manoeuvre: acting on the balance sheet lets him hold a restrictive line without displaying the loathed word of a hike.

The real playing field is on MBS. Part of the committee has long held that the Fed has no business holding mortgage securities, which amounts to indirectly subsidising housing credit. The plan set in December already provides for letting the MBS run off and replacing them with short-term Treasury bills. That is where Warsh can accelerate without triggering a liquidity stress, since the total balance sheet stays stable: he changes the composition, not the size. Shrinking the MBS pocket, still close to $2 trillion, and shortening the portfolio’s maturity toward T-bills, that is the reform he can lead this very year, with the assent of a fraction of the committee.

Why this is the real subject

The balance sheet is the silent lever. Markets scrutinise the dot plot and the press conference, but it is in the composition and trajectory of the balance sheet that the reality of the Warsh mandate of the coming months will play out. Three structural tensions will knot there.

The first pits doctrine against plumbing. Warsh wants a smaller Fed; reserves say there is almost no room to reduce without breaking something. The second pits the Fed against the Treasury. A state whose financing needs are exploding has an interest in the central bank remaining a stable buyer of its debt; a Fed that retreats by selling its Treasuries pushes up the government’s borrowing cost at the worst moment. The third pits displayed independence against advocated coordination. By calling to set the balance-sheet target hand in hand with Bessent, Warsh risks turning a monetary-policy tool into an instrument of public-debt management, exactly the reproach the hawks addressed yesterday to the pandemic-era Fed.

The orientation of the coming months therefore reads thus. On rates, an imposed status quo. On the balance sheet, no brutal relaunch of QT, too dangerous, but a targeted offensive on MBS and portfolio maturity, presented as a technical normalisation while it carries a strong doctrinal intention. Warsh will not be able to make the Fed as small as he dreams. He can, on the other hand, make it more discreet, shorter in duration, and less present in the mortgage market. It is less spectacular than a regime change. It is already a change of regime.

Sources

1. Federal Reserve, Policy Normalization, end of runoff on 1 December 2025, decline of more than $2.2 trillion since June 2022 ($1.6trn of Treasuries, $600bn of MBS), share of GDP from 33% to 20%: https://www.federalreserve.gov/monetarypolicy/policy-normalization.htm
2. Congressional Research Service (Congress.gov), balance sheet from $8.9 trillion in 2022 to $6.5 trillion in 2025, QT ended in December 2025, about half of the pandemic expansion reversed: https://www.congress.gov/crs-product/IF12147
3. StreetStats, balance-sheet composition on 3 June 2026: $6,711bn of assets, $4,469bn of Treasuries, $1,965bn of MBS: https://streetstats.finance/liquidity/fed-balance-sheet
4. PrimeRates, peak of $8.97 trillion in April 2022, total at $6.66 trillion, reverse repo near-emptied: https://primerates.com/primerate/fed-balance-sheet/
5. Wolf Street, 4 December 2025, total QT of $2.43 trillion over three years and five months, MBS at $2.05 trillion, plan to replace MBS with T-bills: https://wolfstreet.com/2025/12/04/fed-balance-sheet-qt-37-billion-in-november-2-43-trillion-from-peak-to-6-54-trillion/
6. Banking Exchange, 26 November 2025, halt of Treasury runoff on 1 December, reserves at $2.89 trillion, stress threshold $2.5-2.7 trillion, MBS runoff continues: https://www.bankingexchange.com/news-feed/item/10480-treasury-market-resilience-and-the-early-end-to-balance-sheet-runoff
7. Federal Reserve / Benzinga, 30 October 2025, end of QT announced, balance sheet at $6.59 trillion, rate lowered to 3.75-4.00%: https://benzinga.com/markets/macro-economic-events/25/10/48506713/federal-reserve-decision-october-30-25-basis-point-fed-funds-rate-balance-sheet-qt-quantitative-tightening
8. CNBC, 17 July 2025, Warsh on regime change, the credibility deficit, coordination with the Treasury on the balance-sheet target: https://www.cnbc.com/2025/07/17/kevin-warsh-touts-regime-change-at-fed-and-calls-for-partnership-with-treasury.html
9. QuantSandbox, peak of $8.95 trillion in April 2022, equilibrium balance-sheet estimates of $6.0-6.5 trillion, debate on holding MBS: https://quantsandbox.orientedplatforms.com/learn/fed_balance_sheet
10. Federal Reserve, Warsh’s swearing-in as 17th chair, 22 May 2026: https://www.federalreserve.gov/newsevents/pressreleases/other20260522a.htm