That’s because Fed holdings and the regime that’s grown to manage interest rates in a system that is flush with cash is not easy to wind back while maintaining market stability and achieving monetary policy goals. It could be even trickier for a Fed chair who is likely to seek easier short-term borrowing costs, because anything that notably contracts central bank bond holdings actually tightens financial conditions.
Warsh, who was a Fed governor between 2006 and 2011, has argued that large Fed holdings distort finances in the economy and what the Fed now holds should be slashed. In a Wall Street Journal opinion story from November, he wrote “the Fed’s bloated balance sheet, designed to support the biggest firms in a bygone crisis era, can be reduced significantly,” with the proceeds redeployed “in the form of lower interest rates to support households and small and medium-sized businesses.”
Warsh’s call to shrink Fed holdings landed as the central bank was nearing the end of what proved to be a three-year effort to reduce the size of bond holdings acquired via aggressive purchases during the COVID-19 pandemic. The Fed bought Treasury and mortgage bonds first to help stabilize traumatized markets at the start of the health crisis, with those purchases morphing into a form of economic stimulus. Crisis buying doubled the size of Fed holdings to a $9 trillion peak in the summer of 2022 before a contraction process known as quantitative tightening, or QT, took overall holdings to $6.6 trillion in late 2025. In December, the Fed started to grow the stock of bonds it holds again via technical purchases of Treasury bills, in a bid to ensure there was enough liquidity in the financial system to provide firm control over its interest rate target range.
More broadly, using the balance sheet as a tool has become a standard part of the monetary policy toolkit, and a critical one given increased probabilities of short-term rates being cut to near-zero levels in times of trouble. Meanwhile, the Fed has developed an entire system of tools to manage rates. And that’s why getting holdings down in a meaningful way would prove so difficult to achieve without creating market chaos.
Warsh “may want a smaller balance sheet and smaller Fed footprint in financial markets,” said Joe Abate, U.S. rates strategist with SMBC Capital Markets, Inc. But, “actually reducing the size of the balance sheet is a nonstarter…Banks want this level of reserves.”Abate was nodding to the fact that when reserves in the banking system ebb to around the $3 trillion mark, notable volatility starts to creep into money market rates, which then threatens the Fed’s ability to manage its interest rate target. This limits how far the Fed can reduce its holdings.Beyond market realities, there’s also the fact that any major change would need buy-in from other Fed policymakers, who’ve largely been on board with the overall arc of using the balance sheet as a policy tool and could oppose efforts to reengineer that part of the toolkit.
LONG PATH TO SMALLER HOLDINGS So how could Warsh get Fed holdings smaller given the realities of what the market will bear? Analysts said easing some of the regulatory burden on how banks manage liquidity, along with moves to make Fed liquidity facilities like the Discount Window and ongoing standing repo operations more attractive, could reduce the appetite for holding reserves and allow a smaller Fed footprint over time. David Beckworth, senior research fellow at the Mercatus Center at George Mason University, said that in addition to those moves, Warsh could include as part of the Fed’s existing periodic framework review actions to reconsider how the Fed uses its balance sheet. There could also be coordination between the Fed and Treasury where the two institutions swap bonds, he said. And while big changes may not be on the cards, there were ways the Fed could tinker with its toolkit to drive down the need to hold lots of liquidity.
“The Fed’s like a ship that slowly turns, that’s probably a good thing, because you don’t want to be so disruptive to the financial system,” Beckworth said.
Evercore ISI analysts agree that any actions Warsh takes on the balance sheet would be slow-moving and mindful of the risks of being aggressive.
“We think he will be more pragmatic than many expect,” the research firm said. “We think he will promise no abrupt changes to Fed balance sheet policy and a Fed-Treasury accord to provide a framework for closer cooperation,” the analysts wrote, adding “the market will read this as giving Treasury Secretary Bessent a soft veto on any QT plans and Warsh will be happy with that.”
