Excellent framing of the Warsh hawk/dove debate Marvin. Gets all of the components on the table. I think in addition to BS shrinkage, the steeper yield curve will tighten financial conditions. And, if both are implemented without triggering a stock market correction or slowing in US growth, a stronger dollar will also tighten financial conditions. So, lower short term rates seem possible, initially. Inflation dynamics are the unknown, and we will have some messy base year effects and supply transitions that complicate the forecast in 2026-27, so it is good to know that Warsh will do what's necessary, should another bout of inflation arrive.
I don't think you can imply that it is a given that Warsh will significantly reduce the balance sheet (QT) without considering bank liquidity and the impact that would have on the repo market. The current Fed has already seen this issue rising in fiscal Q1 and hence initiated "RMP" QE to the tune of $40B/mo. To say that not only will Warsh stop this but actually turn it 180 degrees around with no consideration of creating another dysfunctional repo facility and liquidity crisis in bank reserves is a mistake. I think Warsh will mimic Bessent when he criticized Yellen for the dominance in issuing bills vs coupons and then when he took over, he realized he needed to continue that practice. So will Warsh...I like Lyn Alden's forecast of the "gradual print" as we head deeper into financial repression.
By itself, no, but that’s not what I’m claiming. Bank regulation reform is perhaps even higher on the agenda than slimming down the balance sheet, and that deregulation is what opens the door to a much smaller balance sheet without financial distress (indeed, repo liquidity is likely to improve dramatically with regulatory reform). Sorry to assign homework, but these three pieces explain:
Ha, I was going to go back and click on the links in this article. I like HW! :). And agree on Bessent's requirement of banking deregulation to rejuvenate main street. It's why I bought KRE...I assume (hope...) that there will be some consideration of timing between Warsh and Bessent to make sure deregulation lagging implementation will not be torpedoed by too fast of a move to QT...
Thank you sir. Could be worse. I once read about a guy who was so down he decided to commit suicide by jumping out a fifth-floor window. He lived, but the hot dog vendor he landed on wasn’t so lucky, so he was charged with manslaughter. I think that pretty much defines the worst day ever.
A large wave of maturing government debt creates quiet but powerful pressure on interest rate policy. When old low-coupon bonds roll over into new higher-yield issuance, debt-servicing costs rise mechanically - even without new spending. Lower policy rates don’t solve the debt problem, but they can slow the speed at which refinancing costs reset upward. In that sense, rate cuts are not just about growth or inflation - they also act as a stabiliser for the fiscal transmission channel. The risk, of course, is that using monetary policy to ease debt service blurs the line between price stability and fiscal accommodation.
This is the US Treasury maturity profile: It remains highly skewed towards TBills (short maturity, non-coupon issues) as it has been since Covid. The good news is that the US has been rolling a third of its debt every 3-6 months without problems for half a decade now. The bad news is that it only takes one bad auction!
Fair point - the Treasury maturity profile is indeed heavily skewed toward T-bills, which means rollover risk is operationally manageable as long as auctions clear smoothly. My point wasn’t that refinancing stress is imminent, but that the shorter average maturity increases the sensitivity of interest expense to policy rates.
When a large share of debt resets within months, not years, the transmission from policy rates to fiscal costs becomes faster and more direct. That mechanically raises the odds of a dovish bias relative to a hawkish one at the margin - because rate cuts slow the pass-through of higher servicing costs, while hikes accelerate it.
So, shorter maturity doesn’t remove the constraint; it actually tightens the link between monetary policy and debt-servicing dynamics.
Yes, to be clear, I’m not convinced that President Trump — who loves to gamble — won’t accidentally fly too close to the sun with debt and leave the US with no choice but default or possible monetisation. My only point is that they aren’t aiming for that or looking at it as an option as it would undermine too many of their other objectives.
From an Austrian economics perspective, once a system becomes structurally dependent on cheap credit, the choice set narrows dramatically. A genuine liquidation phase - where rates stay high, and malinvestment is cleared - would likely mean a deep depression, which is politically unattainable in a modern democracy.
That leaves only variants of monetary accommodation: repression, inflation, or indirect monetisation. Not because policymakers “want” it, but because the alternative is politically impossible.
So I don’t see the maturity profile as removing the constraint - it just accelerates how quickly fiscal stress feeds back into monetary policy decisions. The adjustment may not come as an explicit default, but history suggests it often takes the form of currency dilution instead.
Yes, I saw that. Nice to see one of my favorite academics agreeing with me! It is amusing to see how many in the business media and sell side “research” either are completely ignorant of what the Accord actually was or purposely misrepresent it.
Treasury ~ Fed Agreement, Who’s on First :) Coordination, focus on Consolidated balance sheet, leave all the heavy lifting to Uncle Bill. Talk the talk, semantic shifts, only reducing duration of Fed holdings via more bill purchases, enabling Treasury to more easily fund more deficit spending thru 2028. Fed will purchase additional 500 Billion Bills in 2026.
how can warsh hike significantly given the level of federal debt and the size of the deficit? hiking would increase the deficit, which would increase issuance, which would further increase rates in the absence of accommodation. isn't this a doom loop?
What matters for debt sustainability are real interest rates (across the coupon curve) and the real growth rate of the economy, not nominal interest rates (remember, tax receipts grow with inflation). As long as real average coupon rates remain below real growth in the economy, all is fine…IF you balance the primary (non-interest) budget. That’s the problem: primary deficit is running at about 3% of GDP, so they need to get that down, regardless of what the Fed does. But, if they pursue irresponsible policy at the Fed - i.e. try to artificially repress policy rates - real interest rates across the rest of the coupon curve (via term premia) will rise, undermining debt sustainability. This is the popular misconception: that the Fed can’t raise frontend policy rates; no, what matters is the level of the rest of the yield curve, which will rise if the Fed screws up again like it did in 2020-’21.
getting nominal growth above nominal rates is the key for financial repression to lower the debt/gdp ratio. how about shifting issuance even more to the front end, abolishing the slr for treasury paper, and floating iorb at 10-20bps below 3 mo bills. that will let warsh shrink the fed's balance sheet while softly capping long rates and lowering the whole curve.
Best to think in real rates terms, not nominal, because of term premia. What you suggest could work, but only if everyone maintains faith in the system, which I doubt in this environment. Otherwise it is likely to raise term premia (increasing real financing costs), and over reliance on front-end financing is likely to bring those term premia forward, raising even real TBill rates. Monetary finance is always a confidence game, and one you sow mistrust, it’s over, no matter what you do.
that's when you have to get to serious financial repression. e.g. regulatory changes to force institutions to hold more treasury paper, the slr/iorb maneuvers to drain reserves in favor of tbills, an slr of zero gives the banks free money, more purchases by the fed, forcing ira's and 401k's to hold non-tradable treasuries [for our own good, of course] or better yet force them into gov't sponsored annuities [for our own good] so that the capital just disappears. didn't peru just confiscate all private pension holdings? nominal is where it's at for financial repression.
Excellent framing of the Warsh hawk/dove debate Marvin. Gets all of the components on the table. I think in addition to BS shrinkage, the steeper yield curve will tighten financial conditions. And, if both are implemented without triggering a stock market correction or slowing in US growth, a stronger dollar will also tighten financial conditions. So, lower short term rates seem possible, initially. Inflation dynamics are the unknown, and we will have some messy base year effects and supply transitions that complicate the forecast in 2026-27, so it is good to know that Warsh will do what's necessary, should another bout of inflation arrive.
Great discussion of our different views (unfortunately, poor audio) in the latest Thematic Edge podcast: https://thematicmarkets.substack.com/p/episode-009-trump-21-shock
I don't think you can imply that it is a given that Warsh will significantly reduce the balance sheet (QT) without considering bank liquidity and the impact that would have on the repo market. The current Fed has already seen this issue rising in fiscal Q1 and hence initiated "RMP" QE to the tune of $40B/mo. To say that not only will Warsh stop this but actually turn it 180 degrees around with no consideration of creating another dysfunctional repo facility and liquidity crisis in bank reserves is a mistake. I think Warsh will mimic Bessent when he criticized Yellen for the dominance in issuing bills vs coupons and then when he took over, he realized he needed to continue that practice. So will Warsh...I like Lyn Alden's forecast of the "gradual print" as we head deeper into financial repression.
By itself, no, but that’s not what I’m claiming. Bank regulation reform is perhaps even higher on the agenda than slimming down the balance sheet, and that deregulation is what opens the door to a much smaller balance sheet without financial distress (indeed, repo liquidity is likely to improve dramatically with regulatory reform). Sorry to assign homework, but these three pieces explain:
https://seriouslymarvin.substack.com/p/fiscal-dominance-narratives-versus
https://seriouslymarvin.substack.com/p/the-bank-that-swallowed-a-fly
https://seriouslymarvin.substack.com/p/regulatory-arbitrage
Ha, I was going to go back and click on the links in this article. I like HW! :). And agree on Bessent's requirement of banking deregulation to rejuvenate main street. It's why I bought KRE...I assume (hope...) that there will be some consideration of timing between Warsh and Bessent to make sure deregulation lagging implementation will not be torpedoed by too fast of a move to QT...
Yes, US banks (particularly vs European banks) was one of my end-of-2025 calls for 2026. So we’re more in agreement than it appeared!
I remember you talking about Warsh back in a Dec 2025 issue, well done, take a bow. Seriously!
So good, so far said the man that fell out of a 20 story building as he passed the 10th floor.
Thank you sir. Could be worse. I once read about a guy who was so down he decided to commit suicide by jumping out a fifth-floor window. He lived, but the hot dog vendor he landed on wasn’t so lucky, so he was charged with manslaughter. I think that pretty much defines the worst day ever.
LOL, yes - one must be prepared for the vicissitudes of life
A large wave of maturing government debt creates quiet but powerful pressure on interest rate policy. When old low-coupon bonds roll over into new higher-yield issuance, debt-servicing costs rise mechanically - even without new spending. Lower policy rates don’t solve the debt problem, but they can slow the speed at which refinancing costs reset upward. In that sense, rate cuts are not just about growth or inflation - they also act as a stabiliser for the fiscal transmission channel. The risk, of course, is that using monetary policy to ease debt service blurs the line between price stability and fiscal accommodation.
This is the US Treasury maturity profile: It remains highly skewed towards TBills (short maturity, non-coupon issues) as it has been since Covid. The good news is that the US has been rolling a third of its debt every 3-6 months without problems for half a decade now. The bad news is that it only takes one bad auction!
Fair point - the Treasury maturity profile is indeed heavily skewed toward T-bills, which means rollover risk is operationally manageable as long as auctions clear smoothly. My point wasn’t that refinancing stress is imminent, but that the shorter average maturity increases the sensitivity of interest expense to policy rates.
When a large share of debt resets within months, not years, the transmission from policy rates to fiscal costs becomes faster and more direct. That mechanically raises the odds of a dovish bias relative to a hawkish one at the margin - because rate cuts slow the pass-through of higher servicing costs, while hikes accelerate it.
So, shorter maturity doesn’t remove the constraint; it actually tightens the link between monetary policy and debt-servicing dynamics.
Yes, to be clear, I’m not convinced that President Trump — who loves to gamble — won’t accidentally fly too close to the sun with debt and leave the US with no choice but default or possible monetisation. My only point is that they aren’t aiming for that or looking at it as an option as it would undermine too many of their other objectives.
From an Austrian economics perspective, once a system becomes structurally dependent on cheap credit, the choice set narrows dramatically. A genuine liquidation phase - where rates stay high, and malinvestment is cleared - would likely mean a deep depression, which is politically unattainable in a modern democracy.
That leaves only variants of monetary accommodation: repression, inflation, or indirect monetisation. Not because policymakers “want” it, but because the alternative is politically impossible.
So I don’t see the maturity profile as removing the constraint - it just accelerates how quickly fiscal stress feeds back into monetary policy decisions. The adjustment may not come as an explicit default, but history suggests it often takes the form of currency dilution instead.
https://open.substack.com/pub/johnhcochrane/p/a-new-fed-treasury-accord?r=1z5qli&utm_medium=ios
Yes, I saw that. Nice to see one of my favorite academics agreeing with me! It is amusing to see how many in the business media and sell side “research” either are completely ignorant of what the Accord actually was or purposely misrepresent it.
Pretty Picture :) https://www.cbo.gov/publication/61882
Treasury ~ Fed Agreement, Who’s on First :) Coordination, focus on Consolidated balance sheet, leave all the heavy lifting to Uncle Bill. Talk the talk, semantic shifts, only reducing duration of Fed holdings via more bill purchases, enabling Treasury to more easily fund more deficit spending thru 2028. Fed will purchase additional 500 Billion Bills in 2026.
https://home.treasury.gov/system/files/221/TBACCharge1Q12026.pdf
https://www.bobdylan.com/songs/times-they-are-changin/
The line it is drawn
The curse it is cast
The slow one now
Will later be fast
As the present now
Will later be past
The order is rapidly fadin’
And the first one now will later be last
For the times they are a-changin’
how can warsh hike significantly given the level of federal debt and the size of the deficit? hiking would increase the deficit, which would increase issuance, which would further increase rates in the absence of accommodation. isn't this a doom loop?
What matters for debt sustainability are real interest rates (across the coupon curve) and the real growth rate of the economy, not nominal interest rates (remember, tax receipts grow with inflation). As long as real average coupon rates remain below real growth in the economy, all is fine…IF you balance the primary (non-interest) budget. That’s the problem: primary deficit is running at about 3% of GDP, so they need to get that down, regardless of what the Fed does. But, if they pursue irresponsible policy at the Fed - i.e. try to artificially repress policy rates - real interest rates across the rest of the coupon curve (via term premia) will rise, undermining debt sustainability. This is the popular misconception: that the Fed can’t raise frontend policy rates; no, what matters is the level of the rest of the yield curve, which will rise if the Fed screws up again like it did in 2020-’21.
getting nominal growth above nominal rates is the key for financial repression to lower the debt/gdp ratio. how about shifting issuance even more to the front end, abolishing the slr for treasury paper, and floating iorb at 10-20bps below 3 mo bills. that will let warsh shrink the fed's balance sheet while softly capping long rates and lowering the whole curve.
Best to think in real rates terms, not nominal, because of term premia. What you suggest could work, but only if everyone maintains faith in the system, which I doubt in this environment. Otherwise it is likely to raise term premia (increasing real financing costs), and over reliance on front-end financing is likely to bring those term premia forward, raising even real TBill rates. Monetary finance is always a confidence game, and one you sow mistrust, it’s over, no matter what you do.
that's when you have to get to serious financial repression. e.g. regulatory changes to force institutions to hold more treasury paper, the slr/iorb maneuvers to drain reserves in favor of tbills, an slr of zero gives the banks free money, more purchases by the fed, forcing ira's and 401k's to hold non-tradable treasuries [for our own good, of course] or better yet force them into gov't sponsored annuities [for our own good] so that the capital just disappears. didn't peru just confiscate all private pension holdings? nominal is where it's at for financial repression.