The nomination of Kevin Warsh to the Federal Reserve opens a delicate question about the future path of the central bank's balance sheet, according to research from Wolfe Research. In a client note, analyst Tobin Marcus argued that a range of outcomes - from additional accommodation to renewed tightening - are plausible as policy priorities shift under President Donald Trump.
Marcus framed the current environment as one in which several unconventional tools are already in play. He described the White House as executing a "novel form of quasi-QE" through roughly $200 billion of purchases of government-sponsored enterprise mortgage-backed securities (GSE MBS). At the same time, Marcus pointed to the Powell Fed's recent move toward modest reserve management purchases aimed at keeping bank reserves "ample" and alleviating strains in funding markets.
Counterbalancing those dovish elements, Marcus emphasized Warsh's documented preference for a smaller and simpler Fed balance sheet, suggesting that Warsh could favor quantitative tightening if he follows his prior views. Yet Wolfe Research judges the likely near-term outcome to be limited net change in the Fed's footprint in bond markets.
The note outlines an apparent operating assumption from Treasury Secretary Bessent that GSE purchases could be targeted to "match the runoff of ~ $15b per month" in Federal Reserve MBS, while additional reserve purchases would be used to offset growth in the deficit. That pairing, Wolfe contends, would leave the overall federal presence in the market broadly steady.
On the dovish flank, Marcus acknowledged the possibility that the administration could increase GSE MBS buying, though he warned of diminishing effectiveness. He stressed a key distinction: the Fed can create money, whereas the GSEs must finance any expansions of their holdings. The note also records that leadership at the Federal Housing Finance Agency has denied reports of broadened MBS purchases.
Marcus described more aggressive QT as an unlikely path because "material QT... would put upward pressure on the long end of the yield curve," a dynamic that would run counter to the administration's housing objectives and could reawaken strains in funding markets. Wolfe Research concluded that, notwithstanding public rhetoric, substantive balance-sheet changes are unlikely and that 10-year yields and consumer lending rates are likely to remain "stickily high."
Key points
- Both additional easing and quantitative tightening are plausible policy paths, according to Wolfe Research, creating a complex outlook for the Fed's balance sheet.
- The administration is already using about $200 billion in GSE MBS purchases described as a "quasi-QE," while the Fed has shifted to modest reserve management purchases to keep reserves ample.
- Wolfe Research expects little meaningful change to the federal footprint in bond markets, which implies that long-term yields and consumer rates will likely remain elevated.
Risks and uncertainties
- Escalation of GSE MBS purchases could have limited impact and would require financing by the GSEs rather than money creation by the Fed - relevant for the housing and mortgage market.
- Material quantitative tightening would likely push up the long end of the yield curve, conflicting with housing affordability goals and posing risks to funding conditions - relevant for fixed-income markets and banks.
- Conflicting policy aims between the administration's housing priorities and a Fed inclined toward a smaller balance sheet create uncertainty for consumer borrowing costs and mortgage markets.