Imagining a Modern Fed-Treasury Accord
Lawrence Gillum | Chief Fixed Income Strategist
Last Updated: February 11, 2026
In the February 2 Weekly Market Commentary, we noted the Federal Reserve’s (Fed) potentially constrained policy conditions as resilient growth and above‑trend inflation are intersecting with an increasingly unsustainable fiscal trajectory. That implicit linkage may now be shifting toward something more explicit if Kevin Warsh and Treasury Secretary Scott Bessent get their way.
Warsh has suggested a modernized Fed–Treasury accord to reset boundaries blurred by high deficits, elevated debt levels, and the Fed’s post‑crisis balance sheet expansion. Drawing on the 1951 accord — which restored Fed independence by ending its obligation to cap Treasury yields — he argues today’s high‑debt environment and a balance sheet above $6 trillion warrant a similar effort to re‑establish clarity between fiscal and monetary roles.
Warsh’s comments suggest the accord would emphasize transparency and coordination without fully subordinating monetary policy to fiscal needs. Key elements could include:
- Joint Communication on Balance Sheet and Issuance Plans: A new accord could have the Fed and Treasury jointly communicate balance sheet objectives and debt‑issuance plans to give markets clearer guidance during quantitative tightening (QT). Warsh argues this transparency would help the Fed move toward a sustainable balance sheet size while reducing reliance on reactive policy tools.
- Narrower Fed Footprint in Markets: The accord might limit the Fed’s use of quantitative easing (QE), restricting large‑scale bond buying to true crises and shifting holdings toward shorter‑term Treasuries. Warsh favors a smaller balance sheet to re‑establish boundaries between monetary and fiscal policy. The Fed’s current long‑duration tilt — holding significant amounts of long‑term Treasuries and mortgage-backed securities (MBS) — would likely be reduced gradually over several years.
It May Take Time to Meaningfully Shrink the Fed’s Balance Sheet
Source: LPL Research, Bloomberg 02/10/26
Disclosures: Past performance is no guarantee of future results.
- Addressing Fiscal Pressures Without Yield Caps: While a concern is that this could evolve into “yield curve control” — where the Fed caps long-term rates to manage debt costs — Warsh’s hawkish stance on balance sheets suggests initial restraint. And you could arguably make the case that this is already happening.
- The Fed is notably underweight Treasury bills and significantly overweight in long- duration bonds. Currently, Treasuries with maturities of 10 years or more make up nearly 38% of the Fed’s holdings, compared to just 18% of the outstanding Treasury market. While other sectors are roughly aligned, this imbalance reflects the Fed’s reinvestment strategy and its historical focus on longer-dated securities. This skew toward the long end of the curve already resembles aspects of an “Operation Twist” in terms of duration extension.
- Perhaps instead, the accord might prioritize fiscal discipline by aligning policies to handle 6–7% deficits (as a percent of GDP) in non-crisis times, potentially through creative maneuvers like adjusting Treasury issuance mixes (e.g., more T-bills), while the Fed steps back from long-end support. That said, if market dysfunction arises (e.g., auction failures or rising term premiums), it could open the door to targeted interventions, though Warsh has emphasized avoiding permanent tools that blur independence.
- Safeguards for Independence: To counter concerns about eroding Fed autonomy, the accord could explicitly delineate roles, such as barring the Fed from direct deficit financing while allowing coordination during normalization. Warsh has framed this as a response to the Fed “losing its way” by straying into fiscal territory, aiming to refocus on core mandates like price stability and employment. Critics warn it risks heightening political pressure or bond volatility if perceived as fiscal dominance
Of course, Congress won’t sit idly. Bipartisan concerns over Fed independence could spark pushback. Oversight hearings, resolutions, or conditions on Warsh’s confirmation could force modifications, especially if the accord requires legislative tweaks for durability. Congress holds veto power over statutory changes, making a “skinny” version more feasible than an ambitious overhaul.
Bottom Line: Overall, this accord would likely be a formal, public framework announced jointly by Warsh (if confirmed, as we expect) and Treasury Secretary Bessent, focusing on predictability to manage debt without immediate aggressive easing. Market reactions could include steeper yield curves initially, with dollar strength if seen as pro-sound money, but bear steepening if independence fears dominate. The exact terms remain ambiguous, as Warsh and Bessent have not detailed them, but it could represent a shift toward integrated yet bounded policymaking in a high-debt era.
Important Disclosures
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