#WalshSaysToCautiouslyShrinkBalanceSheet

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US Treasury's Bessent says Fed will take its time on balance sheet moves
February 5
February 8
In recent economic discussions and central bank commentary, there has been growing emphasis on the need to shrink the Federal Reserve’s balance sheet with caution rather than aggressively. This approach is gaining attention because it touches on some of the most debated aspects of U.S. monetary policy in 2026 — from inflation control to market liquidity and financial stability.
Although the exact phrasing “Walsh says to cautiously shrink balance sheet” has not appeared as a direct quote in major outlets, the broader policy conversation reflects that central bank policymakers and advisors are signaling a careful and gradual approach to balance sheet reduction if and when it resumes.

What This Balance Sheet Discussion Is About
Since the global financial crisis and again during the COVID-19 pandemic, the U.S. Federal Reserve expanded its balance sheet dramatically by purchasing Treasury securities and mortgage-backed bonds to support economic activity. At its peak, holdings approached about $9 trillion. Then, via quantitative tightening, the Fed allowed much of that to roll off, reducing the total to roughly $6.6 trillion by late 2025.

However, that process has slowed or paused recently because of concerns about liquidity and market pressure. Central banks are now debating how and whether to shrink the balance sheet further without destabilizing short-term funding markets.

Cautious Balance Sheet Management — Key Signals
1. Officials Urge Patience and Care
Recent comments from U.S. Treasury and Federal Reserve observers suggest that the Fed will not rush into shrinking the balance sheet. Instead, policymakers want to ensure that liquidity remains sufficient for markets to function smoothly and that financial conditions do not tighten unexpectedly if assets are withdrawn too quickly.

Treasury Secretary Scott Bessent said the Fed could take up to a year or more to determine its path on balance sheet policy and may prioritize stability over a rapid reduction.

This “wait and see” stance aligns with the idea of cautiously shrinking instead of aggressively reducing the supply of reserves.
2. Risks to Money Markets and Repo Activity
Analysts and strategists widely point out that balance sheet reduction — technically called quantitative tightening — can put stress on the repo market, where banks lend and borrow short-term liquidity from each other. If the Fed pulls back too quickly, this could push up repo rates and squeeze financial institutions’ day-to-day funding.

Because of that risk, institutions like Citigroup suggest the bar for restarting balance sheet reduction remains high. A more gradual approach would help avoid renewed volatility.

3. Policy Tension With Political Goals
There is another nuance in the balance sheet debate. President Trump has emphasized goals such as lower mortgage rates to support housing affordability. Shrinking the Fed’s holdings of long-term bonds could have the opposite effect by putting upward pressure on longer-term interest rates. This highlights a real policy trade-off between reducing the Fed footprint and keeping borrowing costs low.

This tension reinforces the argument for caution — shrinking the balance sheet too quickly could have broader impacts beyond inflation, affecting credit markets and housing.
Why Balance Sheet Reduction Matters
The size of the central bank’s balance sheet influences financial conditions in several ways:
Liquidity in banking and money markets — More reserves support easier funding; shrinking them can tighten conditions.
Interest rates and borrowing costs — Selling or allowing assets to mature reduces monetary accommodation and can push yields up.
Inflation and inflation expectations — A larger balance sheet is often associated with more monetary support; reducing it can signal policy tightening.
Market confidence and stability — Abrupt moves can spook investors and stress banks or non-bank intermediaries.
Because each of these channels touches real economic outcomes, policymakers usually prefer gradual adjustments rather than abrupt changes. This explains why cautious balance sheet shrinkage — if attempted at all — is widely advocated.
Broader Fed Policy Context
The discussion around balance sheet size is closely linked to the Federal Reserve’s monetary policy strategy. Central bankers use two primary tools:
Interest rate policy, which directly affects short-term borrowing costs, and
Balance sheet policy, which influences longer-term yields and liquidity conditions.
In recent times, rate decisions have dominated headlines. But as inflation moderates and the economy shows resilience, balance sheet policy has moved into focus again as a tool for fine-tuning monetary conditions and restoring “normal” monetary footing.
Some officials argue that a smaller balance sheet could provide more policy room in future downturns, giving the Fed greater flexibility to respond next time a crisis hits.
Market and Investor Response
Financial markets closely monitor comments about balance sheet policy because they influence expectations for future liquidity and interest rates. Asset prices — including stocks, bonds, and cryptocurrencies — react not just to actions but to perceptions about intent and timing.
In the current environment:
Bond yields and mortgage rates could rise if investors believe the Fed will reduce its holdings of long-term securities.
Risk assets such as equities and crypto may experience volatility if tightening conditions accelerate.
Liquidity-sensitive sectors may adjust asset pricing based on expectations of less central bank support.
What Happens Next
The next major milestones in this policy debate include:
Ongoing internal Fed discussions about the appropriate level of reserves and the timing of any reduction.
Feedback from financial markets and money market indicators that signal whether the system can absorb further contraction.
Coordination with Treasury policy as political priorities — such as mortgage rates — may influence the pace of action.
The ongoing confirmation or transition process for the Fed Chair, which will shape the institution’s strategic direction.

The conversation around shrinking the Federal Reserve’s balance sheet has shifted from theoretical to practical and measured. Instead of bold quantitative tightening, policymakers and advisors are emphasizing caution, gradualism and careful monitoring of market signals. This reflects a broader consensus that reducing the central bank’s footprint in financial markets — while potentially beneficial for long-term monetary discipline — must be balanced against risks of liquidity stress and tightening financial conditions.
The idea of cautiously shrinking the balance sheet is becoming part of mainstream policy rhetoric because it acknowledges the complex trade-offs between inflation control market stability and credit conditions. Markets will continue to watch this debate closely, as any shift in balance sheet policy could have economy wide and cross-asset implications.