Warsh's Efforts to Shrink Fed Balance Sheet May Not Wreck Markets

The prospect of a Fed chair determined to shrink asset holdings may not be the risk-off moment for the market that it appears to be.

Published on Feb. 3, 2026

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As a potential Federal Reserve chair, Kevin Warsh could be expected to take a more aggressive approach to shrinking the central bank's balance sheet. However, the prospect of a Fed chair determined to shrink asset holdings may not be the risk-off moment for the market as it appears on the surface. The mechanical link between the balance sheet and risk-asset performance has unraveled due to factors like more muscular fiscal policy and earnings growth, weakening the once-tight link between the Fed's money printing and market performance.

Why it matters

Warsh's approach to the Fed's balance sheet could have significant implications for the markets and the broader economy. If he overdoes the balance sheet reduction, it could cause dollar-funding stress, tumult in the Treasury market, or reserve scarcity, forcing him to reverse course. However, the current regulatory framework and practical obstacles may limit how quickly Warsh can shrink the balance sheet.

The details

The Fed's balance sheet, consisting mostly of Treasurys and mortgage-backed securities, is currently at $6.6 trillion, down nearly $3.5 trillion from its peak. Warsh, who has criticized the Fed's quantitative easing (QE) program in the past, may have more leeway to shrink the balance sheet. However, the mechanical link between the balance sheet and risk-asset performance has weakened in recent years due to factors like more muscular fiscal policy and earnings growth. This raises both perils and opportunities for Warsh, as he will need to balance the practical obstacles and regulatory framework that dictate how much in reserves banks need to hold and the composition of assets they need to keep.

  • The Fed halted quantitative tightening (QT) in late-2025 and recently has begun expanding the balance sheet again through bill purchases.
  • The Fed implemented new rounds of QE each time bank reserve requirements rose and the economy slowed, with halting QE resulting in market damage, most notably in 2010 and 2018.

The players

Kevin Warsh

A former Federal Reserve governor who has been critical of the Fed's quantitative easing program and may be nominated as the next Fed chair by President Donald Trump.

Dario Perkins

The managing director of global macro at TS Lombard, who believes that QE was overrated and there is no mechanical relationship between the Fed's balance sheet and anything that matters.

George Goncalves

The head of U.S. macro strategy at MUFG, who believes that a Warsh-led Fed would not quickly reduce the balance sheet due to the need for changes in bank regulation.

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What they’re saying

“QE was always overrated, and there is no mechanical relationship between the Fed's balance sheet and anything that matters.”

— Dario Perkins, Managing Director of Global Macro, TS Lombard (TS Lombard)

“We do not believe further QT, if attempted, would pose a material threat to either asset prices or the broader economy.”

— Dario Perkins, Managing Director of Global Macro, TS Lombard (TS Lombard)

“Warsh has advocated for a 'regime change' that involves rapidly shrinking the Fed's balance sheet. In our view, we do not expect a Warsh-led Fed to quickly reduce the balance sheet as there would need to be many changes on bank regulation before that happens.”

— George Goncalves, Head of U.S. Macro Strategy, MUFG (MUFG)

The takeaway

The prospect of a Fed chair determined to shrink the central bank's balance sheet may not be the risk-off moment for the market that it appears to be. The mechanical link between the balance sheet and risk-asset performance has weakened in recent years, and Warsh would face practical obstacles and regulatory constraints in rapidly reducing the balance sheet, suggesting a more gradual approach may be necessary.