Warsh Will Face Challenges Shrinking Fed's Portfolio, Citi Says

Core Viewpoint - Federal Reserve Chair nominee Kevin Warsh is expected to adopt a gradual approach to reducing the central bank's $6.6 trillion portfolio to prevent renewed tensions in the money markets [1] Group 1: Balance Sheet Management - Any attempt to resume unwinding the Fed's balance sheet, known as quantitative tightening, could lead to pressures in the $12.6 trillion repurchase market [2] - The Federal Open Market Committee (FOMC) is likely to prefer a gradual approach to balance sheet management to avoid volatility similar to that experienced in October 2025 [3] - Warsh has advocated for significantly reducing the Fed's financial footprint, which expanded due to asset purchases during the global financial crisis and the COVID-19 pandemic [3] Group 2: Current Strategies and Options - The Fed halted the reduction of its portfolio after an increase in government borrowing caused a cash squeeze in money markets, leading to a pivot towards monthly Treasury bill purchases [4] - A Warsh-led Fed could consider options such as reducing the weighted average maturity of its holdings by rolling longer-maturity Treasury securities into short-dated debt [5] - The Fed may also decrease its T-bill purchases from approximately $40 billion per month or allow its mortgage-backed securities to roll off [6] Group 3: Future Projections - An analysis from Citi indicates that even if the Fed stops its purchases by June, reserves are unlikely to decline significantly by December 2026, with a projected reduction in purchase pace to about $20 billion per month starting in mid-April [7] - The New York Fed anticipates that reserve management purchases will remain high for a few months to counter expected increases in non-reserve liabilities during the tax season [8] - The minutes from the December FOMC meeting revealed a preference for T-bill purchases to shift the Fed's portfolio composition towards Treasury securities [9]