The prospect of Kevin Warsh returning to the US central bank as Federal Reserve chair has rapidly altered the conversation in global markets. For months, investors were preoccupied with whether a Trump-backed nominee would push for faster rate cuts. With Warsh now under consideration, the focus has pivoted to a far deeper structural question: the size and role of the Fed’s balance sheet.

Warsh, a former Fed governor from 2006 to 2011, has spent years criticising the central bank’s expansion of its asset holdings through quantitative easing. During his tenure, the Fed’s bond-buying programme was introduced as an emergency tool after the global financial crisis. Since then, successive rounds of QE during crises - most notably the pandemic - have expanded the balance sheet to roughly $6.6 trillion.

He has argued publicly that this prolonged asset expansion distorted markets, suppressed borrowing costs artificially, encouraged excessive risk-taking on Wall Street, and enabled fiscal indiscipline by lawmakers. His position aligns closely with US Treasury Secretary Scott Bessent’s thinking that monetary policy has overreached into areas that should be left to fiscal authorities.

Markets reacted quickly to the possibility of his appointment. Longer-term US Treasury yields moved higher, the dollar strengthened, and gold and silver prices declined as traders began pricing in the possibility of a more aggressive reduction in the Fed’s asset holdings rather than a policy centred purely on rate adjustments.

The practical challenge Warsh would inherit is immense. When he left the Fed in 2011, the balance sheet was a fraction of its current size. Over the past decade and a half, the US financial system has adapted to what policymakers call an “ample reserves” framework, where abundant liquidity in the banking system ensures smooth settlement of payments and compliance with regulatory liquidity requirements.

This framework was tested in 2019 when modest balance sheet reductions led to stress in money markets and a spike in short-term lending rates, forcing the Fed to intervene. A similar but milder squeeze occurred in late 2025 when rising government borrowing and ongoing quantitative tightening drained liquidity, prompting the Fed to halt QT and resume buying short-term Treasury bills at a pace of around $40 billion a month.

These episodes underline how sensitive modern money markets are to changes in reserve levels. Any attempt to materially shrink the Fed’s footprint risks tightening financial conditions in ways that may conflict with the administration’s goal of keeping long-term borrowing costs low.

Warsh has suggested that this trade-off can be managed. In interviews, he has argued that if balance sheet reduction pushes long-term yields higher, the Fed could offset that tightening by cutting short-term policy rates more deeply. This reflects a philosophy that the central bank should influence markets primarily through its benchmark rate rather than through large-scale asset ownership.

He has also called for what he describes as a new “Treasury-Fed accord,” invoking the 1951 agreement that cemented central bank independence. In his view, the Fed and Treasury should clearly communicate an explicit objective for the size of the Fed’s balance sheet rather than allowing it to expand and contract in response to crises without a long-term framework.

Analysts note that implementing such changes would not be straightforward. The chair is only one vote on the Federal Open Market Committee, and many current members support maintaining ample reserves to prevent funding stress. A materially smaller balance sheet may require changes to bank liquidity regulations and supervisory frameworks, areas that lie beyond pure monetary policy.

Strategists have outlined possible paths Warsh could pursue. One option would be to stop Treasury bill purchases and allow funding costs to rise gradually. Another would be to adjust the maturity profile of the Fed’s holdings toward shorter-term securities that better match its liabilities. Currently, the weighted average maturity of Fed assets exceeds nine years, while its liabilities are closer to six years.

Even incremental changes could unsettle markets that have grown accustomed to abundant central bank liquidity. Money markets, bank funding costs, and Treasury yield curves would all be directly affected by any shift in how quickly reserves are withdrawn.

A sustained rise in US long-term yields typically leads to tighter global financial conditions. For India, this can translate into foreign portfolio outflows from debt and equity markets, pressure on the rupee, and higher domestic bond yields. Gold price volatility, already visible after the news, can also influence Indian investor sentiment given the metal’s domestic demand profile.

Indian banking, NBFCs, and rate-sensitive sectors such as real estate and automobiles could feel indirect effects if global yields harden and domestic borrowing costs rise. IT services companies may see currency-related impacts if the dollar strengthens further.