Key Points:
- President Trump nominated Kevin Warsh, a critic of asset buying, as Fed Chair.
- Warsh wants to reduce the Fed’s $6.6 trillion balance sheet significantly.
- Markets reacted with higher long-term bond yields and crashing gold prices.
- Cutting the balance sheet too fast could cause cash shortages for banks.
President Donald Trump has picked Kevin Warsh to lead the Federal Reserve, and the conversation on Wall Street has changed instantly. Before the nomination, everyone asked how fast interest rates would fall. Now, traders are worrying about the Fed’s massive $6.6 trillion balance sheet. Warsh is a known critic of the central bank’s habit of buying up huge amounts of debt. He believes this practice encourages reckless risk-taking and government overspending.
Markets reacted quickly to the nomination. On Friday, yields on long-term Treasury bonds went up, the dollar got stronger, and precious metals like gold and silver took a nosedive.
Investors expect Warsh to push for a rapid reduction in the Fed’s assets. He has previously argued that the Fed needs to “run the printing press a little bit less” and let the Treasury Department handle the nation’s finances.
However, Warsh faces a tricky balancing act. If he shrinks the balance sheet too fast, it could actually drive up long-term borrowing costs. This would clash with the Trump administration’s goal of cheap loans for homebuyers and businesses. Warsh might argue that by slimming down the bank’s assets and tightening financial conditions that way, he gains the freedom to cut the benchmark short-term interest rate even deeper.
Shrinking the Fed’s footprint is easier said than done. The financial system now relies heavily on the cash reserves the Fed provides. Just late last year, a shortage of cash caused a squeeze in money markets, forcing the Fed to start buying bonds again to keep things running smoothly. If Warsh cuts off this support, banks could run short on liquidity, causing interest rates to spike unpredictably.
Some strategists think Warsh might try to change what the Fed buys rather than just how much, focusing on shorter-term debt. Whatever his plan, he will need to convince other Fed members to join him.
Since the chair only has one vote, sweeping changes won’t happen overnight. Still, the message to the market is clear: the era of the Fed buying endless amounts of debt may be ending.
