Trump's Fed Pick Targets $6.6T Balance Sheet

If Donald Trump selects Kevin Warsh to lead the Federal Reserve in 2026, the new chairman's first major challenge won't be interest rates—it will be the central bank's colossal $6.6 trillion balance sheet. For years, Warsh has been a vocal critic of the Fed's massive asset holdings, a position that is already sending ripples through financial markets.

When the news of his potential nomination broke, bond yields rose, the dollar strengthened, and both gold and silver prices fell. "He's been very critical of the Fed's balance sheet expansion," noted Zach Griffiths of CreditSights, summarizing the market's reaction to a potential policy overhaul.

A Policy Clash: Shrinking the Fed vs. Lowering Rates

A central tension defines the situation: Kevin Warsh’s goal to shrink the Fed's footprint seems to directly conflict with President Trump's desire for lower borrowing costs. In January, Trump directed Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities specifically to reduce home loan costs for consumers.

Warsh, however, has consistently argued against using the Fed's balance sheet to suppress rates. This philosophical divide creates a potential policy puzzle. "If you take Kevin at his word that he dislikes balance sheet expansion as a way to compress yields, then it means it falls onto Treasury," explained Greg Peters at PGIM Fixed Income.

This approach aligns with Treasury Secretary Scott Bessent, who shares Warsh's view that the Fed should scale back its market interventions. The core idea is to let private markets operate more freely. However, a smaller Fed balance sheet could lead to higher long-term interest rates—the very outcome Trump aims to prevent.

Stephen Miran, a Trump appointee currently at the Fed, suggested a possible workaround on Bloomberg TV. "In theory, you can move the short rate to offset whatever you're doing on the balance sheet," he said. "If that pushes long rates higher, you can cut the short rate to balance things out."

Warsh's Long-Standing Critique of Fed Policy

Warsh’s skepticism toward a large balance sheet is not new. While at the Fed from 2006 to 2011, he initially supported quantitative easing during the 2008 financial crisis but grew disillusioned as the policy continued. He ultimately left the central bank over disagreements on its refusal to scale back asset purchases.

He argues that the Fed went too far in its interventions during both the 2008 crisis and the COVID-19 pandemic, where it bought trillions in government debt to stabilize the financial system.

On Fox Business, Warsh outlined his preferred strategy: "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."

He has also called for a modern version of the 1951 Treasury-Fed Accord, which established the central bank's independence from financing government debt. "We need a new Treasury-Fed accord," he told CNBC, suggesting a formal agreement to define the appropriate size of the balance sheet.

The Practical Hurdles of a Smaller Balance Sheet

Despite support for a reduced Fed footprint, implementation would be complex. "Anything that reduces the financial footprints of the Federal Reserve would be a good thing," said Peter Boockvar of OnePoint BFG, while acknowledging the balance sheet remains "huge in size."

The primary obstacle is the Fed's current operational model, the "ample reserves framework," which was established after 2008. This system relies on a large balance sheet to ensure commercial banks have sufficient liquidity to meet regulatory requirements.

According to Joseph Abate from SMBC Nikko, the size of the balance sheet is largely dictated by banks' regulatory needs. If Warsh were to shrink it too aggressively, banks could face short-term funding stress. This isn't just a theoretical risk. At the end of 2025, the Fed's attempt to reduce its holdings combined with increased government borrowing drained cash from the system, forcing a reversal. The Fed had to start buying $40 billion in short-term Treasuries each month just to maintain market stability.

Barclays strategists Samuel Earl and Demi Hu outlined potential paths for Warsh:

• End the monthly Treasury purchases and allow funding costs to rise.

• Restructure the Fed’s portfolio toward shorter-term debt. Currently, the average maturity of the Fed's assets is over nine years, while its liabilities average around six years.

Navigating the Fed's Internal Politics

Even as chair, Warsh would not have unilateral power. He holds just one of the votes on the Federal Open Market Committee (FOMC), the body that sets monetary policy.

While analysts at JPMorgan noted that some Fed members might be receptive to his ideas, the majority currently supports the ample reserves framework. Any significant change would require a broad consensus and likely a major overhaul of existing bank regulations.

As Vail Hartman at BMO put it, "a significantly smaller balance sheet would likely require a major shift in the Fed's existing bank regulatory framework." Shrinking the Fed’s $6.6 trillion portfolio is a monumental task that would face technical, political, and institutional resistance.