A new accord, a new curve – Warsh’s blueprint for the US Fed

While Kevin Warsh, the Trump administration’s nominee for Federal Reserve chair, was a more hawkish member of the Federal Open Market Committee during his term as Fed governor, his recent views have shifted in favor of rate cuts while remaining a consistent proponent of reducing the Fed’s balance sheet. He’s called for a new Treasury-Fed accord, outlining an agreement for a smaller balance sheet.

• If he sways others, expect downward pressure on short-term rates, but this risks higher long-term yields and a steeper curve. However, changes are unlikely anytime soon, and his views may be moderated by the need to find a consensus.
• The Federal Open Market Committee is cautious about large balance-sheet reductions because they drain bank reserves and can destabilize the repo market, like in 2019. Concern over reserve scarcity led the FOMC to halt quantitative tightening in December.
• Banks and dealers already hold sizable Treasury positions. If the Fed shrinks holdings and regulatory changes don’t unlock enough private demand, the long end could sell off, tightening financial conditions and weighing on the economy, even if policy rates are cut.