Since the U.S.-Israeli-led war with Iran began in February, oil prices have surged, reigniting inflation, which the Fed was already struggling to bring back to its 2 percent target. At the same time, the job market, after showing signs of softening, appears relatively solid for the moment. The conflicting signals have complicated the Fed’s job, which is to keep prices relatively stable and unemployment low.
After a series of rate reductions last year, the Fed paused its cuts and is expected to keep rates at a range of 3.5 to 3.75 percent. Policymakers are unlikely to pivot to rate cuts unless the job market shows stronger evidence of weakening.
Here’s where various consumer rates stand now:
Mortgage Rates
Rates on 30-year fixed-rate mortgages don’t move in tandem with the Fed’s benchmark rates; instead, they generally track with the yield on 10-year Treasury bonds, which is influenced by a variety of factors, including the Fed’s actions, expectations about inflation and general investor sentiment.
Mortgage rates have been volatile. In late February, they fell below 6 percent for the first time in more than three years, but reversed course after the U.S.-Israeli attacks on Iran, given the likelihood of higher inflation. That sent yields on the 10-year bond higher, which, in turn, pushed up mortgage rates.
In recent weeks, mortgage rates have been trending lower again: The average rate on a 30-year fixed mortgage was 6.23 percent as of April 23, according to Freddie Mac, down from 6.3 percent the week before and 6.81 percent a year ago.
“Rates currently stand at their lowest level in the last three spring home-buying seasons,” Sam Khater, Freddie Mac’s chief economist, said in a statement. “This improvement, coupled with a pickup in purchase applications and refinance activity, as well as an increase in monthly pending home sales, underscores signs of improving momentum in the market.”
Other home loans are more closely tethered to the central bank’s decisions. Home-equity lines of credit and adjustable-rate mortgages, which carry variable interest rates, generally adjust within two billing cycles after a change in the Fed’s rates.
Credit Cards
Cardholders carrying balances have seen the rates they pay on their debt decline ever so slightly over the last several months, but not enough to meaningfully affect their monthly budgets. (When the Fed cuts rates, card issuers are generally slower to act, and changes could take a couple of billing cycles.)
Last week, the average interest rate on credit cards was 19.57 percent, according to Bankrate, which tracks more than 100 popular new card offerings by the largest 50 banks. That’s down from 20.79 percent in August 2024, the highest rate since 1985.
Auto Loans
Higher car prices, combined with elevated loan rates, continue to strain affordability for many Americans, while many lower-income households are struggling to make payments on the auto loans they already hold.
Many car loans tend to track the yield on the five-year Treasury note, which is influenced by the Fed’s rate moves. But other factors determine how much borrowers actually pay, including credit history, the type of vehicle, the loan term and the down payment. Lenders also consider the levels of borrowers becoming delinquent on auto loans. As those move higher, so do rates, which makes qualifying for a loan more difficult, particularly for people with lower credit scores.
The average rate on new car loans was 7.0 percent in March, according to Edmunds, an auto research and shopping website, up from 6.5 percent at the end of last year but down from 7.2 percent in March 2025.
Rates for used cars were higher: The average loan carried an 11 percent rate in March, up from 10.5 percent at the end of the year but down from 11.5 percent in March 2025.
Savings Accounts
Everything from online savings accounts and certificates of deposit to money market funds tend to move in line with the Fed’s policy changes. High-yield savings accounts have fallen a bit from their most recent highs roughly two years ago, but they still pay far more than rates for traditional savings accounts, which remain anemic.
The national average savings account rate was recently 0.59 percent, according to Bankrate, while the best high-yielding savings accounts pay around 4 percent.
The average yield on the Crane 100 Money Fund Index, which tracks the largest money-market funds, was 3.47 percent as of April 27, down from 3.73 percent on Dec. 9 and 5.13 percent at the end of last June.
Student Loans
There are two main types of student loans: federal and private.
Most people turn to federal loans first. Their interest rates are fixed for the life of the loan, they’re easier for teenagers to get, and the repayment terms are more generous.
Last year, rates on federal student loans, for money borrowed from July 1, 2025, through June 30, 2026, dropped modestly. (These rates reset on July 1 each year and follow a formula based on the 10-year Treasury bond auction in May.)
Undergraduate loans now carry a rate of 6.39 percent, down from 6.53 percent a year earlier. Rates on loans for graduate and professional students eased to 7.94 percent, from 8.08 percent, while rates on PLUS loans — extra financing available to graduate students and to parents of undergraduates — fell to 8.94 percent, from 9.08 percent.
Private student loans are more of a wild card. Undergraduates often need a co-signer, rates can be fixed or variable, and much depends on your credit score.
The combination of higher inflation and slower growth is particularly challenging for the Fed, and has prompted policymakers to endorse holding interest rates steady in a range of 3.5 percent to 3.75 percent for an extended period.
On Wednesday, the Fed will release a new policy statement alongside its rate decision at 2 p.m. in Washington. Mr. Powell, whose term ends May 15, will hold what is likely to be his final news conference as chair at 2:30 p.m. Pressure is now on the Senate to confirm President Trump’s pick to replace him, Kevin M. Warsh, in time. Mr. Warsh is expected to take the first step toward winning confirmation on Wednesday, just hours ahead of the Fed meeting.
Here is what to watch for:
Impact of the War
When officials last gathered in March, the United States was less than three weeks into its war with Iran. The closure of the Strait of Hormuz, a crucial shipping lane for global energy markets, had begun to gum up supply chains and lift energy prices, but the full extent of the economic impact was impossible to know.
Mr. Powell, at the time, leaned into the uncertainty of the moment, saying repeatedly that officials had “no conviction” in their forecasts when it was still so unclear how long the war would last and, in turn, how long energy prices would stay elevated.
“The thing I really want to emphasize is that nobody knows,” he told reporters.
Six weeks later, officials are facing the possibility of a much more protracted war, which risks keeping energy prices elevated.
The longer that price pressures linger, the more likely they broaden to other areas, like the services sector, and begin to push up inflation in a more sustained way. There is also a concern that at some point consumers will be forced to pull back on other spending in order to cover higher energy-related expenses, which would undermine a key pillar that is propping up the economy.
Mr. Powell will likely be under pressure to provide more specificity around the Fed’s views on the economic outlook, and how it is thinking through scenarios related to an prolonged conflict.
Rate Increases on the Table?
Until the war with Iran, the primary debate at the Fed centered around when — not whether — officials would restart rate cuts.
But the emergence of another inflation shock has begun to change the nature of the Fed’s internal discussions.
No official yet sees a rate increase as the most probable outcome this year, as Mr. Powell made clear during March’s news conference.
“We are balancing these two goals in a situation where the risks to the labor market are to the downside — which would call for lower rates — and the risks to inflation are to the upside — which would call for higher rates, or not cutting, anyway,” he said at the time.
Minutes from that meeting, however, showed an increasing number of officials supporting the idea of keeping rate increases on the table, or at the very least communicating that there were roughly equal odds that the next move could be up rather than down.
Mr. Powell will no doubt face questions about where officials now stand on the matter. Economists will also be looking out for changes to language in the Fed’s policy statement, which currently indicates the conditions under which the central bank would consider the “extent and timing of additional adjustments” to rates. An amendment to that line would send a strong signal that the Fed’s thinking around its next steps has shifted.
When Will Powell Leave?
If all goes according to plan and the Senate confirms Mr. Warsh by May 15, Mr. Powell’s tenure as Fed chair will end. But his time at the central bank may not be over. Technically, he can stay on as a governor until January 2028.
Mr. Powell’s decision hinges first and foremost on the outcome of a criminal investigation by the Justice Department into cost overruns for renovations at the central bank’s headquarters in Washington and whether he lied to Congress about them.
The investigation prompted a rare public rebuke from Mr. Powell, who said it was nothing more than a coercive tool to get the Fed to comply with the president’s demands for lower rates. Mr. Powell also made clear he would not leave the Fed until the investigation was “well and truly over, with transparency and finality.” Ultimately, he said he would base his decision on what is “best for the institution and for the people we serve.”
The investigation, which was stymied by a federal judge, also angered Senate Republicans, including Thom Tillis of North Carolina, who vowed to block any of Mr. Trump’s Fed nominees until Mr. Powell’s legal threats ended.
On Friday, the Justice Department announced it would drop the investigation and refer the matter to the Fed’s internal watchdog.
The Justice Department’s move was sufficient for Mr. Tillis to lift his block and allow Mr. Warsh’s nomination to proceed. Lawmakers are set to hold a vote on Wednesday morning to advance the nomination to the full Senate.
But it is unclear whether the Justice Department’s de-escalation will give Mr. Powell enough closure to leave. Jeanine Pirro, the U.S. attorney for the District of Columbia, said she would “not hesitate” to reopen the investigation again if needed.
Mr. Tillis also suggested the Justice Department might still appeal the federal judge’s ruling that quashed the subpoenas against the Fed. He said such a move would be not about pursuing Mr. Powell but about defending the power of prosecutors to issue subpoenas. An appeal would only further encourage Mr. Powell to stay.
New leadership at the Fed will not automatically usher in a sea change in the outlook for interest rates, however. Since December, officials have kept them in a range of 3.5 percent to 3.75 percent, much to Mr. Trump’s chagrin. The president wants substantially lower borrowing costs and has made it clear that he expects Mr. Warsh to deliver them.
But Fed policymakers project no urgency to restart rate cuts, and Mr. Warsh has said he did not promise Mr. Trump to ease policy in order to get the job, even as Senate Democrats have questioned whether he would serve as the president’s “sock puppet.” On Wednesday, the Fed is widely expected to hold rates steady again. In fact, traders in financial markets that track the trajectory of rates predict no pivot toward cuts at all this year.
“The path to cutting is one that is much more fraught now than it seemed a few months ago,” said Nathan Sheets, chief economist at Citi and a former official at the Treasury Department.
The Fed’s caution around rate cuts crystallized in the wake of the war with Iran, which is pushing inflation further from the central bank’s 2 percent target while raising the specter of slower economic growth.
A roughly 50 percent jump in oil prices since the start of the war on Feb. 28 has rippled across the economy, lifting gasoline costs, airfares and shipping fees. Soaring fertilizer prices have prompted concerns about rising grocery bills, which would add yet another expense for Americans who have faced higher prices in the last year because of Mr. Trump’s tariffs. The latest Consumer Price Index report showed that annual inflation was 3.3 percent in March, almost a full percentage point higher than the pace in February.
The longer energy prices remain elevated, “the greater the chances that higher inflation gets embedded across a wide variety of goods and services, various supply chain effects start to emerge, and real activity and employment start to slow,” Christopher J. Waller, a Fed governor who was in the running to replace Mr. Powell, said in a speech this month.
Just a handful of months ago, Mr. Waller was so worried about the labor market that he voted for a quarter-point rate cut in January. Monthly jobs growth has started to pick back up again, and the unemployment rate has steadied around 4.3 percent, indicating a more stable situation.
Against this backdrop, even some of Mr. Trump’s biggest supporters have changed their tune about rate reductions. Treasury Secretary Scott Bessent said this month that the Fed should “wait and see” before lowering borrowing costs. Stephen I. Miran, who consistently called for aggressive rate cuts after Mr. Trump appointed him as a Fed governor last year, has endorsed a slower pace of reductions in light of what he described as “a little bit less favorable” inflation dynamics.
“Energy developments have changed the distribution of risks,” he said in public remarks recently. “They’ve increased the risks of higher inflation.”
For Jon Faust, a fellow at the Center for Financial Economics at Johns Hopkins University and a former senior adviser to Mr. Powell, those comments suggest that “everyone but Trump is resigned, no matter who’s chair, to a sustained hold until things clarify some.”
Support for cuts is unlikely to grow unless the labor market takes a turn and starts to deteriorate more notably. Policymakers will also want to have tangible evidence that inflation from both the war and last year’s tariffs has subsided. Some officials seem willing to acknowledge that the Fed is equally likely to have to consider rate increases, although no one yet thinks that is the most probable outcome.
As chair, Mr. Warsh would have sway over the rate debate but not final say. Decisions are made by a 12-person committee, which also includes the six other members of the board of governors, the president of the Federal Reserve Bank of New York and a rotating set of four presidents from the 12 regional banks.
Among those who could still get a vote is Mr. Powell.
Just days before the Fed’s policy meeting was set to begin on Tuesday, it was not entirely clear if he would step down as chair when his term ended on May 15. A criminal investigation into Mr. Powell and the central bank had held up Senate confirmation of Mr. Warsh. Mr. Powell had pledged to remain chair temporarily if Mr. Warsh was not confirmed in time.
But on Friday, the ground shifted. In an about-face, the Justice Department dropped its inquiry into renovations at the Fed’s headquarters in Washington, but kept open the possibility of restarting it at any point. By Sunday, Senator Thom Tillis of North Carolina, a pivotal Republican on the Banking Committee, said federal prosecutors had given him sufficient assurances that Mr. Powell’s legal threats were over.
Mr. Powell still faces a high-stakes decision on whether to stay on as a governor, which he can do until January 2028. That would prevent Mr. Trump from filling the seat with someone more amenable to his wishes to lower rates and gain more control over the central bank.
Mr. Powell has said he would not leave the board until the criminal investigation was “well and truly over, with transparency and finality.” He added that his decision would depend on what he thought was “best for the institution and for the people we serve.”
Mr. Tillis suggested on Sunday that the Justice Department might still appeal a federal judge’s ruling that quashed the subpoenas against the Fed. He said such a move would be not about pursuing Mr. Powell but about defending the power of prosecutors to issue subpoenas. An appeal, however, is likely to encourage Mr. Powell to stay.
That could make for an awkward transition period for Mr. Warsh, who wants to pursue sweeping changes to the way the Fed operates, including the data it favors to make rate decisions, how it communicates any policy pivots and its footprint in financial markets.
Mr. Warsh’s ability to enact these changes would require broad internal support, something he would have to build while also managing Mr. Trump’s ire if he did not pursue the policy that the president wanted.
“I don’t think he gets much of a honeymoon period,” Mr. Faust said. “He’ll be in the firing line Day 1.”
But Jeanine Pirro, the U.S. attorney for the District of Columbia, said on Friday that the Justice Department would drop the matter, which focused on cost overruns in a renovation of the Fed’s headquarters. Even though Ms. Pirro said that she would “not hesitate” to reopen the criminal investigation, her move to stand aside still proved sufficient for Mr. Tillis, who said on NBC’s “Meet the Press” that he was ready to move forward with a key, first committee vote on Mr. Warsh.
“They have made it very clear that the current investigation is completely and fully ended,” Mr. Tillis said of his conversations with the Justice Department.
The senator said those discussions gave him the assurances he needed “to feel like they were not using the D.O.J. as a weapon to threaten the independence of the Fed.”
Mr. Tillis’s vote is pivotal in determining whether Mr. Warsh, who served as a Fed governor from 2006 to 2011, will be confirmed by the time Mr. Powell’s term officially ends on May 15. While Mr. Warsh enjoys broad Republican support, Senate Democrats have called him a “sock puppet,” given President Trump’s insistence that he would pick only someone who supported lower rates to replace Mr. Powell.
Republicans hold a slim 13-to-11 majority on the Banking Committee, which oversees the Fed, meaning Mr. Tillis’s opposition had created an insurmountable deadlock there. Lawmakers are set to hold a vote on Wednesday to advance Mr. Warsh’s nomination to the full Senate.
If confirmed, Mr. Warsh, will assume leadership of an institution that has had to defend its ability to operate independently amid an extensive pressure campaign from White House for lower interest rates.
The criminal investigation into Mr. Powell and the Fed was the latest broadside from the administration, coming on the heels of an attempt by Mr. Trump to oust Lisa D. Cook, a sitting governor, last year. That case is currently before the Supreme Court.
Mr. Trump has also threatened to fire Mr. Powell if he decides to stay on at the central bank after his term as chair ends in May. He can stay on as a governor until 2028.
Mr. Powell has yet to disclose whether he will do so but has stipulated that he will only leave once the investigation into him and the Fed is “well and truly over, with transparency and finality.”
He is likely to face questions about his future this week at a news conference after the Fed’s next policy meeting, at which officials are expected to hold rates steady as they grapple with an ongoing energy shock from the war in Iran.
In her statement Friday, Ms. Pirro said that the investigation into Mr. Powell would instead be handled by the inspector general for the Fed. That office has been reviewing the matter since July.
Mr. Tillis described the watchdog on Sunday as credible, while brushing aside recent comments by Mr. Trump and his deputies that suggested that they might still continue to scrutinize Mr. Powell. Those actions, the senator said, had essentially backfired for the president by slowing down the confirmation of Mr. Warsh.
“That’s the absurdity of this whole thing. If this is investigation, which is now closed, had never occurred, we wouldn’t be having this discussion. He would have been confirmed by May 15,” the senator said, adding he expected the Senate to act by that date, when Mr. Powell’s term ends.
Mr. Tillis also said he was unconcerned about the possibility that Ms. Pirro could soon return to court and appeal a decision that had blocked her from issuing a subpoena against Mr. Powell. The judge in that case quashed the request on grounds that the investigation itself was politically motivated.
The senator said he believed that the appeal sought to challenge a part of the ruling that did not affect Mr. Powell, though he pointed out that the Fed chair might stay on at the central bank as a governor while the case resolves.
Mr. Trump had been defiant in the days before prosecutors dropped the investigation, which focused on whether Mr. Powell lied to Congress about costly renovations of the Fed’s headquarters. The president has continually blasted — and inflated — the price of the $2.5 billion project, saying earlier this week that he had to “find out how this can happen.”
Even after the prosecutors halted their work, the Trump administration still sought to frame the inquiry as ongoing. Karoline Leavitt, the White House press secretary, pointed to an independent review underway by the Fed’s inspector general.
“The investigation still continues, it’s just under a different authority,” she told reporters.
Ms. Pirro insisted on Friday that she would “not hesitate to restart a criminal investigation should the facts warrant doing so,” creating some doubt about whether Mr. Powell and the Fed will come under scrutiny again.
Mr. Trump has repeatedly pushed prosecutors across the country to investigate his adversaries even in the face of scant evidence or legal justification. While Ms. Pirro’s decision to shelve the inquiry into Mr. Powell was a retreat, it also reflected Mr. Trump’s willingness to use the criminal justice system as a tool to achieve political outcomes — in this case, his desire to have Mr. Warsh confirmed quickly.
The Powell investigation had been a roadblock to what would otherwise have been a smooth confirmation along party lines for Mr. Warsh. A top Republican on the Senate Banking Committee, Thom Tillis of North Carolina, vowed to block any of Mr. Trump’s nominees until the legal threats against Mr. Powell were dropped.
Earlier this week, Mr. Tillis posted on social media that while Mr. Warsh was a “great nominee” to be Fed chair, he would only vote to confirm him “once the DOJ drops their bogus investigation into Chairman Powell that threatens the independence of the Fed.”
By Friday afternoon, Mr. Tillis had not yet addressed whether his concerns had been rectified.
Ms. Pirro’s inquiry focused on whether Mr. Powell lied to Congress about the Fed’s $2.5 billion renovation of its headquarters in Washington. The investigation drew a rare rebuke from the Fed chair, who framed the inquiry as part of an effort by Mr. Trump to encroach on the Fed’s independence and pressure policymakers to lower interest rates.
As part of that investigation, prosecutors issued grand jury subpoenas seeking information about the renovations and Mr. Powell’s testimony to Congress. But the subpoenas were blocked in March by James E. Boasberg, the chief judge in Federal District Court in Washington, who handles all matters in front of grand juries. In a blistering opinion, Judge Boasberg described the subpoenas as an attempt “to harass and pressure Powell either to yield to the president or to resign and make way for a Fed chair who will.”
During a closed-door hearing, prosecutors under Ms. Pirro effectively acknowledged that they had no evidence that Mr. Powell had committed any crimes but wanted to press forward with their inquiry anyway.
Just two days ago, Ms. Pirro appeared defiant, promising to appeal Judge Boasberg’s ruling quashing the subpoenas. At a news conference, she assailed the decision, saying it was unacceptable that “a judge can stand at the door of a grand jury and tell a prosecutor you’re not allowed to go in.”
In a post made Friday on her official social media account, Ms. Pirro said that the Federal Reserve’s own inspector general would now be scrutinizing the costs of the renovations and would issue a report in “short order.” But Mr. Powell had directed the Fed’s internal watchdog to look into the project last year.
The Fed’s inspector general said in a statement on Friday that its “evaluation” of the renovation was ongoing. “This assessment includes our independent analysis of the project’s substantial cost increases and overruns. We are actively working to complete our review, and look forward to making the results available to the public and Congress upon completion,” the statement said.
Many Republicans had been subtly nudging the Trump administration to drop the investigation in recent weeks, suggesting that the Senate could be better equipped to look into the renovations. That step, they argued, would ease the roadblocks to Mr. Warsh’s confirmation.
On the morning of Mr. Warsh’s confirmation hearing before the Senate Banking Committee, Senator Tim Scott, chair of the committee, argued on CNBC that Congress could even set up a “special committee” devoted to the matter. He added that the move would allow Mr. Warsh to be confirmed and, in the process, help lawmakers “have access to all the information necessary” to delve into the renovations.
If Mr. Warsh is not confirmed by May 15, Mr. Powell has said that he would stay on as chair on a temporary basis. He can technically remain a member of the Fed’s board of governors until 2028. At a news conference last month, Mr. Powell said he had “no intention of leaving the board until the investigation is well and truly over, with transparency and finality.”
Mr. Trump recently threatened to fire Mr. Powell if he did not leave the Fed when his term ends.
The president is also in the midst of trying to oust another official, Lisa D. Cook, who was appointed a governor by the Biden administration, over unsubstantiated allegations of mortgage fraud. The Supreme Court has yet to rule on the case, but in oral arguments earlier this year, the justices expressed concern about the implications for the Fed’s independence if her firing was allowed to stand.
A president can remove an official only for “cause,” which is long thought to be gross malfeasance while on the job.
Mr. Warsh’s plan to rectify this appears, on the surface, relatively straightforward. He wants the Fed to have a smaller footprint in financial markets and for there to be closer coordination with the Treasury Department on what the Fed holds in its portfolio and what the government issues in terms of debt to fund itself. Mr. Warsh has argued that reducing the central bank’s holdings will give officials space to lower interest rates, something President Trump has long desired. The rationale is that longer-term rates are likely to rise as the balance sheet shrinks, which then could be offset by lowering short-term rates.
Achieving all of this will be anything but straightforward, however. It will take careful planning and a significant amount of time in order to avoid creating damaging volatility.
There are already jitters about the direction that Mr. Warsh will push the Fed if confirmed by the Senate. His path to winning confirmation became much clearer on Friday after the Justice Department dropped a criminal investigation into the central bank. The inquiry had been a major roadblock to Mr. Warsh’s ascent to become chair.
Still, other hurdles remain. Among his first tasks will be to overcome lingering doubts about how susceptible he will be to pressure from the president, who wants more influence over the institution.
But there is a second hitch as well. Fresh in the minds of Fed officials and investors across Wall Street is a 2019 episode in which policymakers reduced the balance sheet by too much, causing short-term interest rates to spike. That episode was a “near heart attack” for markets, said James Clouse, who served as deputy director of the Fed’s division of monetary affairs at that time, leaving a “pretty profound, lasting impact on the way people have thought about the balance sheet.”
That caution remains in force today.
“It’s very clear that the balance sheet cannot be immediately reduced without causing a liquidity crunch that nobody would like,” said Darrell Duffie, a professor of finance at Stanford University’s Graduate School of Business. “Both the plan and the execution are going to make the difference between failure and success.”
What’s on the Fed’s balance sheet?
The Fed’s balance sheet reflects its assets and liabilities.
Its assets include over $4 trillion in Treasury securities and $2 trillion in mortgage-backed securities amassed in past crises as an attempt by the Fed to keep a lid on rates and support the economy.
Its liabilities include extra cash deposits that more than 5,000 banks hold at the central bank, otherwise known as reserves. The amount of reserves fluctuates with the amount of assets the Fed holds. Currency in circulation and the Treasury’s cash coffers represent the central bank’s other major liabilities. At its peak in 2022, its balance sheet totaled nearly $9 trillion.
Since 2008, the Fed has operated an “ample reserves” system to carry out its monetary policy. That entails the Fed supplying more than enough reserves to meet banks’ demands and paying interest on those holdings to create a “floor” for borrowing costs. When the Fed changes the target range of its main policy rate, it either raises or lowers the interest it is paying on those holdings such that rates across the financial system shift accordingly. Before the financial crisis, reserve balances were significantly lower and the Fed was not paying out interest, requiring frequent interventions to ensure supply and demand balanced out.
Last year, reserves dipped below $3 trillion following a three-year period in which the Fed reduced its holdings. Strains soon emerged in short-term markets, where banks and hedge funds borrow cash overnight for trading and to cover daily payments. The Fed reversed course and in December began buying Treasury bills, which mature in one year or less.
Mr. Warsh is cognizant of the potential pitfalls of his balance sheet ambitions, telling lawmakers at his confirmation hearing on Tuesday that there would be an extensive debate before proceeding slowly with advance notice to markets. That echoed Treasury Secretary Scott Bessent, who said it could take up to a year for the Fed to make any balance sheet decisions.
While Mr. Warsh declined to say how much smaller he wanted the overall balance sheet to be, he made clear that the Fed should no longer be holding long-term Treasuries, given his concerns that doing so blurs the line between monetary and fiscal policy by suppressing the government’s borrowing costs.
How to Shrink It
Discussions around reducing the balance sheet have multiplied in anticipation of Mr. Warsh’s ascent to Fed chair. For some, the objective itself is questionable. Those in this camp argue that the current system works well because it is simple, requires minimal intervention and allows for the Fed to maintain a firm grip on rates.
One of the most vocal detractors of a significantly smaller balance sheet has been Christopher J. Waller, a governor who at one point competed with Mr. Warsh for the top job.
“You don’t want banks every night of the day digging around in the couch cushions looking for money,” he said at a conference earlier this year. “This is massively inefficient and stupid.”
What he has conceded, however, is that there is a path to reducing banks’ demand for reserves as a mechanism to shrink the balance sheet that would not jeopardize the Fed’s current system for enacting monetary policy.
A slew of new research points to several ways to achieve that. The most popular path revolves around altering regulations to reduce banks’ need to hold reserves.
Policymakers have zeroed in on the liquidity coverage ratio, which requires banks to maintain sufficient funding to meet their obligations for 30 days, as well as internal liquidity stress tests that assess how much an institution would need to weather a severe shock. There has also been a discussion about allowing banks to count whatever capacity they have to borrow at the Fed’s discount window, a facility that provides short-term loans to banks, toward fulfilling their liquidity requirements.
Already, Michelle W. Bowman, the vice chair for supervision, has hinted at rule changes to reduce “liquidity hoarding.” Regulators will have to be careful not to scale back too aggressively, however, or raise the risk that lenders will not be adequately prepared for a crisis, warned Viral Acharya, a professor of economics at New York University.
Lorie Logan, who oversaw balance sheet operations at the Federal Reserve Bank of New York before becoming a regional president in Dallas, has also proposed making the central bank’s lending facilities more accessible. That would encourage banks to hold fewer reserves while also giving them confidence that they have access to cash if need be. This would require reducing negative connotations that have often plagued these facilities, especially the discount window. The fear for lenders has long been that tapping it sends a signal that they are on shaky footing.
One of the easiest ways to mitigate any potential cash crunch during the transition period would be for the Fed to stand ready to intervene when necessary in the form of so-called temporary open market operations.
“You don’t want to create any environment that would increase liquidity pressure on the system,” said Patricia Zobel, who ran the group that executed monetary policy at the New York Fed before joining Guggenheim Investments.
A more aggressive — and likely contentious — lever to pull is for the Fed to pay banks a lower rate on their reserve balances beyond a certain level. That would sharply reduce the incentive for banks to hold extra cash, but it would likely be difficult to structure and face intense pushback from the industry. It could also potentially undermine the Fed’s ability to control rates.
According to Stephen I. Miran, a Fed governor, enacting a combination of the above changes over several years could allow the Fed to reduce its balance sheet by up to $2 trillion while avoiding any extreme market indigestion. “The most important thing we can do will be to go slowly,” he said in a recent speech.
For Mr. Warsh, closer coordination between the Fed and Treasury would also help. Mr. Warsh has floated a revamp of a 1951 agreement that established the Fed’s monetary policy independence while giving Treasury control of government spending and taxation. What a new “accord,” as Mr. Warsh has called it, is likely to entail at a minimum is an alignment in what securities the Fed is willing to hold on its balance sheet and what Treasury wants to issue in terms of government debt. The department’s preference now appears to be Treasury bills, which Mr. Warsh seems to favor for the Fed as well.
Concerns about how independent the Fed will remain under Mr. Warsh has caused concern, however, that closer coordination between the two institutions will just be a first step toward the Fed becoming more enmeshed in the administration. At worst, economists fear some version of “fiscal dominance,” in which the Fed begins to prioritize the government’s financing needs over controlling inflation.
“It’s potentially a slippery slope,” Mr. Acharya said. “No accord is an accord. It is just the first round of compromise that occurs.”
