Barclays(US:BCS) Hua Er Jie Jian Wen·2026-02-11 03:44Core Viewpoint - The article discusses the need for the Federal Reserve to adjust its balance sheet strategy by shifting from long-term to short-term Treasury securities to reduce duration risk and potentially lower policy interest rates [1][19]. Group 1: Current State of the Fed's Balance Sheet - As of early 2026, the Federal Reserve's balance sheet is approximately $6.6 trillion, significantly higher than pre-pandemic levels of $4.4 trillion and $0.9 trillion before the Global Financial Crisis (GFC) [2]. - The balance sheet structure is deemed "distorted" by some analysts, with reserves nearing $3 trillion, accounting for 12% of bank assets [2][16]. - The weighted average maturity (WAM) of the Fed's Treasury holdings is about 9 years, compared to only 3 years before the GFC, indicating a longer duration risk [2][11]. Group 2: Proposed Strategy for Duration Management - The proposed strategy involves the Fed reinvesting maturing securities into short-term Treasury bills (T-bills) instead of similar long-term assets, which could increase T-bill holdings from $289 billion to approximately $3.8 trillion over five years [23]. - This shift would reduce the Fed's portfolio duration from 9 years to about 4 years, aligning more closely with pre-GFC norms [23][24]. Group 3: Coordination with the Treasury - Successful implementation of this strategy requires coordination with the Treasury to avoid market disruptions. If the Treasury increases long-term debt issuance without Fed support, it could lead to a significant supply-demand imbalance in the long-term bond market [25]. - The ideal scenario would involve the Treasury maintaining long-term issuance levels while increasing T-bill issuance to meet the Fed's needs, stabilizing the market [28]. Group 4: Implications for Interest Rates and Market Dynamics - A shorter duration portfolio may lead to an increase in term premiums, necessitating a reduction in policy interest rates to maintain economic stability [29]. - Research indicates that to offset the effects of a shorter duration portfolio, the federal funds rate may need to be lowered by 25 to 85 basis points [29][36].