Smaller Fed Bigger Questions

Key takeaways

To transition smoothly away from an ample reserves regime, the Fed will have to first reduce demand for reserves.
Shortening the duration of the SOMA portfolio could be accelerated with roll-off caps or asset swaps.
Changing the relationship between the Fed and the Treasury–perhaps by reducing the size of the Treasury General Account–could contribute to a smaller balance sheet but would require Treasury-Fed cooperation.

Federal Reserve (Fed) Chair Warsh’s balance sheet task force has the stated goal of examining “the costs, benefits and institutional implications of the Fed’s current balance sheet regime.”¹

The leaders of the task force have varying philosophies regarding the balance sheet. Jeremy Stein favors a large balance sheet. Raghuram Rajan has written extensively about the problematic ratcheting effects of quantitative easing and prefers a smaller balance sheet. Karen Dynan, the third member, has less apparent views as she has not written much about balance sheet questions directly. The task force is supposed to finish its work and make recommendations by the end of the year, so any changes will likely take place beginning in 2027.

The task force could emerge with any one of a broad range of recommendations. We discuss three important aspects of the balance sheet they will likely consider.

The End of the Ample Reserves Regime?

After the 2008 financial crisis, the Fed abandoned its scarce reserves regime. Currently, the Fed operates under an ample reserves regime. Keeping ample reserves means keeping a high supply of cash in the banking system, and, instead of buying and selling small amounts of bonds to control rates, a focus on controlling administered rates, such as the interest on reserve balances and the overnight reverse repo rate.

Reserves as a share of GDP peaked in 2021 at 17%. After the Federal Open Market Committee (FOMC) decided to begin reserve management purchases at the end of 2025, reserves as a share of GDP stabilized at around 9%. In the early 2000s, when the Fed was operating under a scarce reserves regime, reserves as a share of nominal GDP were less than 1%.

Returning to a scarce reserves regime is one way to reduce the size of the balance sheet. If the balance sheet task force recommends returning to a scarce reserves regime, then we would, in the short run, see the Fed buying fewer Treasuries. However, it would be difficult to quickly transition to a scarce reserves regime without causing market turmoil, unless the Fed puts in some policies to lower reserve demand first. To do this, the Fed could study new payment and settlement mechanisms and encourage more use of the discount window or alternative lending facilities like the Standing Repo Facility to lessen banks’ reliance on reserves.

If the Fed chooses to stay in an ample reserves regime, then we will likely see a gradual increase balance sheet size, as Treasuries are purchased to keep up with steadily increasing nominal GDP and currency in circulation.

Shortening the duration of the SOMA portfolio

The Fed is also trying to reduce the duration of its portfolio. A shorter duration portfolio provides more flexible cash management and lower financial risk. Before the financial crisis, the System Open Market Account (SOMA) portfolio had a weighted average maturity (WAM) of approximately 3.25 years. After the pandemic, the WAM of the portfolio gradually increased from seven years to nine years before falling to just over eight years, where it sits today.

The task force is likely to evaluate adjusting the overall maturity length of the portfolio. There are a number of ways the FOMC could accelerate the process of reducing the maturity of the portfolio.

First, the Fed could allow higher roll-off caps for longer-term securities. The proportion of principal being reinvested into short-term bills also provides a lever for finer duration control. Another less traditional avenue would be to swap some longer-term assets for shorter-term ones with the Treasury.

Moving toward a Treasury-only portfolio would also help, but at the current pace of approximately $20 billion per month, it would take about eight more years for the remaining $1.9 trillion of agency mortgage-backed securities (MBS) holdings to roll off the balance sheet.

Simply selling off long-term assets would likely be difficult. With current high rates, the Fed would have to sell securities at a significant loss, and there is also the concern of making sure private demand exists for the new supply of long-duration bonds. Selling MBS could put pressure on mortgage rates and an already strained housing sector. Any change must be gradual to not disturb markets, and Chair Warsh has indicated that any moves will be well communicated.

Changing the relationship between the Fed and the Treasury

The Treasury General Account (TGA), essentially the government’s checking account, has ballooned in size. If the deficit continues to grow or political gridlock (debt ceiling and government shutdowns) problems become more severe, the cash buffer kept in the TGA may have to gradually increase as well. Since the TGA is a liability on the Fed’s balance sheet, a large TGA balance directly adds to balance sheet size. A rapidly changing TGA balance also contributes to volatility in reserve balances. Prior to the 2008 financial crisis, the TGA served more as an operational account rather than the large cash buffer it is today.

The task force will likely analyze some options to reduce the size and volatility of the TGA, but how the TGA is used is a final decision of the Treasury Department. To that end, the Fed would have to cooperate with the Treasury. That cooperation could be formalized by a new Treasury-Fed Accord, which Chairman Warsh has spoken in favor of in the past.

Outlook

U.S.	2025†	2026	2027
GDP (avg. annual % chg.)	2.1	2.4	2.4
CPI (Dec. Y/Y % chg.)	2.7	3.4	2.2
10-Year Treasury (EoP %)	4.17	4.50	4.50
Policy rates (upper bound, EoP %)	3.75	3.75	3.75
Unemployment (EoP %)	4.4	4.3	4.3

Sources: BEA (GDP), BLS (CPI, Unemployment), Federal Reserve (10-Year Treasury and Policy Rates), MIM. As of August 2026.
† Italics denote 2025 actuals.

U.S.	2025†	2026	2027
GDP (avg. annual % chg.)	2.1	2.4	2.4
CPI (Dec. Y/Y % chg.)	2.7	3.4	2.2
10-Year Treasury (EoP %)	4.17	4.50	4.50
Policy rates (upper bound, EoP %)	3.75	3.75	3.75
Unemployment (EoP %)	4.4	4.3	4.3

Sources: BEA (GDP), BLS (CPI, Unemployment), Federal Reserve (10-Year Treasury and Policy Rates), MIM. As of August 2026.
† Italics denote 2025 actuals.

U.S.	2025†	2026	2027
GDP (avg. annual % chg.)	2.1	2.4	2.4
CPI (Dec. Y/Y % chg.)	2.7	3.4	2.2
10-Year Treasury (EoP %)	4.17	4.50	4.50
Policy rates (upper bound, EoP %)	3.75	3.75	3.75
Unemployment (EoP %)	4.4	4.3	4.3

Sources: BEA (GDP), BLS (CPI, Unemployment), Federal Reserve (10-Year Treasury and Policy Rates), MIM. As of August 2026.
† Italics denote 2025 actuals.

In August, we revised our forecast to incorporate both the economic effects of the AI investment boom and the continuing Iran conflict. For growth, we revised our 2026 forecast higher from 2.2% to 2.4%, given continued investment strength. For inflation, we increased our CPI forecast from 3.0% to 3.4%, largely a “mark-to-market” adjustment of headline inflation, given oil prices remained higher for longer than we initially expected. We continue to expect subdued core inflation. Despite weak payrolls growth, the unemployment rate remains low, and we expect this to continue at least through the end of the year.

Even with higher growth and higher inflation, we expect the Fed to remain on hold for the remainder of the year. Some tightening may take place via the balance sheet, and Chair Warsh also seems happy to let markets do some work in the form of higher long-term rates. Markets have continued to price in at least one hike by year-end, which appears to come from emphasizing the effects of oil prices. We see this as overdone.

Risks

In our previous monthly, the biggest risk to our outlook was the Iran war going on longer than initially expected and the resulting impact on oil prices also lasting longer. That risk came to pass, and we ended up revising our inflation forecast again.

The labor market getting significantly worse is a main risk to our baseline outlook. Even though payroll growth has been negative for just one month (July) so far, growth has been smaller each month since the start of the second quarter. Labor force participation has also dropped. The labor market is in a softer place than it was six months ago, even though the unemployment rate has been stable. We would expect the Fed to keep rates on hold unless there is a sudden and sharp deterioration in the labor market.

Smaller Fed, Bigger Questions

Download PDF

Endnotes
¹ Source: US Federal Reserve, as of July 9, 2026

Disclaimer
Readership: This document is intended solely for the addressee(s) and may not be redistributed without the prior permission of MIM. Its content may be confidential, proprietary, and/or trade secret information. MIM and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part.

Risk of loss. Your capital is at risk. Investing in the strategies discussed herein are subject to various risks which must be considered prior to investing. All investments are subject to regional, industry, market, political, regulatory, competitive, business, financial, and other risks. For a more complete list please contact your sales representative. Investment in the strategy described herein is speculative and there can be no assurance that the strategy’s investment objectives will be achieved. Investors must be prepared to bear the risk of a total loss of their investment.

Unless otherwise specified, the information and opinions presented or contained in this document are provided as of the date noted herein. It should be understood that subsequent developments may affect the information contained in this document materially, and MIM shall not have any obligation to update, revise, nor affirm. It is not MIM’s intention to provide, and you may not rely on this document as providing, a complete or comprehensive analysis of MIM’s investment portfolio, investment strategies, nor investment recommendations. You should consult your independent advisors in determining whether such investment or advisory service is appropriate for you in light of your particular circumstances and relevant legal requirements. You may not rely on this document as the basis upon which to make an investment decision.

Past performance is not indicative of future results. There can be no assurance that any investment objective will be met. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. No representation is being made that any investment will or is likely to achieve profits or losses or that significant losses will be avoided. There can be no assurance that investments similar to those described in this document will be available in the future and no representation is made that future investments managed by MIM will have similar returns to those presented herein. Unless otherwise noted, all information herein has been presented in U.S. dollars. Actual returns may increase or decrease due to currency fluctuations.

MIM often uses benchmarks for the purpose of comparison of results. Benchmarks are used for illustrative purposes only, and any such references should not be understood to mean there would necessarily be a correlation between investment returns of any investment and any benchmark.

Any referenced benchmark does not reflect fees and expenses associated with the active management of an investment. MIM may, from time to time, show the efficacy of its strategies or communicate general industry views via modeling. Such methods are intended to show only an expected range of possible investment outcomes, and should not be viewed as a guide to future performance. There is no assurance that any returns can be achieved, that the strategy will be successful or profitable for any investor, or that any industry views will come to pass. Actual investors may experience different results.

Information is unaudited unless otherwise indicated, and any information from third-party sources is believed to be reliable, but MIM cannot guarantee its accuracy or completeness. All information is sourced from MIM unless otherwise noted.

The securities and any other products or services referenced in this document may not be licensed in all jurisdictions, and unless otherwise indicated, no regulator or government authority has reviewed this document, or the merits of the products and services referenced herein. This document and the information contained herein has been made available in accordance with the restrictions and/or limitations implemented by any applicable laws and regulations. This document is directed at and intended for institutional and qualified investors (as such term is defined in each jurisdiction in which the security is marketed). Before acting on any information in this document, prospective investors should inform themselves of and observe all applicable laws, rules and regulations of any relevant jurisdictions and obtain independent advice if required.

Where applicable, the Manager may determine to terminate any arrangements made for marketing the Shares in one or more jurisdictions in accordance with the AIFM Directive and UCITS Directive respectively, as may be amended from time to time. Investors and potential investors can obtain a summary of investor rights and information on access to collective redress mechanisms at www.metlife.com/investments/regulatory-disclosures/investor-rights.

Last updated 31 July 2026. For additional legal and regulatory disclosures including other cross border information, please refer to www.metlife.com/investments/regulatory-disclosures/global-disclosure-statement.

Select your preferences

Disclaimer