Fed chair pick Warsh makes case for smaller Fed holdings in hearing

Key Points:

• Kevin Warsh, President Trump's nominee to lead the Federal Reserve, expressed his intent to work with the Treasury Department to reduce the Fed's large balance sheet, viewing it as a long-term project for the central bank.
• Warsh criticized the current large Fed holdings, arguing they benefit Wall Street over Main Street, keep short-term interest rates higher than necessary, and politicize the Fed's role; he believes a smaller balance sheet could lead to lower interest rates, better inflation control, and a stronger economy.
• Since the 2007 financial crisis, the Fed's balance sheet expanded from under $1 trillion to a peak of $9 trillion in 2022, with current holdings at $6.7 trillion; most Fed officials are unconcerned about the size, focusing instead on effective rate control and financial system liquidity.
• Warsh has not detailed how the Fed and Treasury would coordinate on shrinking the balance sheet, but market observers expect a gradual approach without outright asset sales, emphasizing better communication on Treasury debt issuance plans.
• Emerging frameworks suggest that easing liquidity regulations and encouraging central bank facility usage could reduce demand for reserves, allowing the Fed to hold fewer assets; a smaller balance sheet might raise long-term rates but potentially enable lower short-term rates, though precise effects remain uncertain.