economy
February 3, 2026
Why Kevin Warsh's efforts to shrink the Fed balance sheet might not wreck markets this time
The prospect of a Fed chair determined to shrink asset holdings may not be the risk-off moment for the market that it appears to be.
TL;DR
- The historical correlation between the Fed's balance sheet and the stock market has weakened significantly.
- Quantitative tightening (QT) has not consistently led to market downturns in recent years, unlike previous instances.
- Fiscal policy, earnings growth, and sector-specific gains have become more influential in driving market performance.
- A new Fed chair's attempts to shrink the balance sheet may be constrained by market and commercial banking needs.
- Potential risks of aggressive tightening include dollar-funding stress, Treasury market volatility, and reserve scarcity.
- Regulatory frameworks and the need for bank reserves may act as practical obstacles to rapid balance sheet reduction.
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