The debate since President Trump nominated Kevin Warsh as his next Fed Chair has centered on whether Mr. Warsh will line up with the administration’s call for lower rates. That would be easy enough. The larger question is what magic he’ll have to cut policy rates while simultaneously shrinking the Fed’s massive holdings of Treasuries–and how he’ll do both without market mayhem that threatens the Fed’s self-mandated “financial stability”?
Businesses and households care less about the Fed’s policy rate for overnight loans. They want to know how much “term premium” they’re required above the policy rate to borrow for longer. Bond markets set that price, not the Fed—unless they want to keep yields artificially low buy buying the bonds themselves. That’s the lazy solution that has been used for the past 17 years, exploding the Fed’s balance sheet holdings from $800 billion to almost $9 trillion between the ’08 financial crisis and COVID, and it’s still $6.6 trillion today after inflation-induced “tightening”.
