Kevin Warsh signals support for new Fed-Treasury accord to redefine central bank role

Kevin Warsh, Donald Trump’s nominee to lead the Federal Reserve, has signaled his support for a modernized version of the 1951 Fed-Treasury Accord, a move that would fundamentally recalibrate the relationship between the US central bank and the Department of the Treasury.

While the original 1951 agreement significantly limited the Fed’s influence on the bond market, the landscape has shifted dramatically following the purchase of trillions of dollars in securities during the global financial crisis and the Covid-19 pandemic. Today, the constraints of that historic deal are largely defunct.

Neither Warsh nor Treasury Secretary Scott Bessent have yet provided a granular roadmap for their actions once the new Fed leadership takes office. However, in a CNBC interview last year, Warsh suggested that a renewed accord could “clearly and carefully” define the scope of the Fed’s balance sheet while outlining the Treasury’s debt issuance strategies.

A renewal might manifest as a primarily bureaucratic adjustment with minimal short-term impact on the $30 trillion Treasury market. However, a more ambitious effort to overhaul the Fed’s current portfolio—which exceeds $6 trillion—could trigger heightened volatility and deepen existing anxieties regarding the independence of the US central bank.

The looming figure over these Fed-Treasury discussions is Trump, who argued last year that one of the central bank’s responsibilities in setting interest rates should be the oversight of government borrowing costs. These costs currently hover around $1 trillion annually, accounting for roughly half of the federal budget deficit.

The 1951 Accord was designed specifically to end such practices. During and after World War II, the Fed capped yields on both short- and long-term Treasury bonds to keep federal borrowing costs low. This policy, however, became a catalyst for soaring post-war inflation. In a landmark shift, the Truman administration eventually agreed to grant policymakers the autonomy to set interest rates independently, cementing the Fed’s operational sovereignty.

In April, Warsh contended that the Fed had effectively violated the principles of 1951 through the large-scale bond purchases executed in the wake of the financial crisis and the pandemic. In various interviews and speeches, he has argued that these interventions “incentivized reckless government borrowing.”

Bessent has echoed these criticisms, accusing the central bank of maintaining quantitative easing (QE) for too long, which he claims damaged the market’s ability to provide critical financial signals. The Treasury Secretary, who oversaw the vetting process for Jerome Powell’s successor, has advocated for the Fed to utilize QE only in “genuine emergencies and in coordination with the rest of the government.”

Consequently, a new agreement could explicitly stipulate that—outside of daily liquidity management—the Fed would only engage in large-scale Treasury purchases with the department’s approval, with the ultimate goal of halting monetary expansion when market conditions allow.

However, involving the Treasury in Fed decision-making in this manner is subject to varied interpretations. Krishna Guha of Evercore ISI noted that investors might interpret such a move as granting Bessent a “soft veto” over any quantitative tightening (QT) plans.

A more concrete version of the agreement would likely codify what many market participants already anticipate: a shift in the Fed’s holdings from medium- and long-term securities toward Treasury bills with maturities of 12 months or less. In this scenario, the Treasury could reduce bond sales or at least limit their increase.

In its quarterly refunding announcement on Wednesday, the Treasury Department drew a direct link between its issuance plans and the Fed’s actions, noting that it is closely monitoring the central bank’s recent increase in bond purchases.

“We are moving toward closer cooperation between the Fed and the Treasury Department,” said Jack McIntyre of Brandywine Global. “The real question is how far that cooperation will expand.”

Conversely, some investors worry that such moves could signal a pivot away from the Fed’s primary mandate of fighting inflation, potentially increasing volatility and raising inflation expectations. In a worst-case scenario, the appeal of the US dollar and the “safe haven” status of Treasury bonds could be compromised.

Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle Investments, warned: “If there is an agreement implying the Treasury can rely on the Fed to purchase a portion of the debt or a segment of the yield curve for the foreseeable future, that is very, very problematic.”

On the other hand, Mark Dowding, chief investment officer at RBC BlueBay Asset Management, argues that Warsh remains committed to keeping the Fed distinct. “This does not rule out further cooperation, but it reduces the likelihood of a formal, binding agreement,” he noted.

Others have proposed broader scenarios where the Fed becomes part of a multi-stage effort to revitalize federal influence over the bond market. Guha of Evercore ISI floated the idea of the Fed swapping its $2 trillion mortgage-backed security (MBS) portfolio for Treasuries.

While such a move faces significant hurdles and remains unlikely, one objective could be to lower mortgage rates—a key focus for the Trump administration. Last month, the President instructed Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities to limit borrowing costs for prospective homebuyers.

Richard Clarida, global economic advisor at PIMCO and former Fed Vice Chair, wrote that a new accord could “provide a framework over time for the Fed to reduce its balance sheet size in coordination with the Treasury and perhaps housing agencies like Fannie Mae and Freddie Mac.”

Warsh almost certainly cannot forge a unilateral agreement with Bessent. However, several current Fed policymakers have supported shifting the portfolio toward shorter-term debt, arguing that its heavy exposure to long-term assets no longer reflects current market structures.

Strategists at Deutsche Bank have predicted that a Warsh-led Fed would be an active buyer of T-bills over the next five to seven years. In one scenario, they foresee T-bills rising from their current level of under 5% to as much as 55% of the portfolio.

Nevertheless, a Treasury shift toward selling bills rather than interest-bearing bonds would be costly. Constantly rolling over massive amounts of debt would increase the volatility of the Treasury’s borrowing costs.

Whether a formal accord is reached or not, market participants now expect a significantly tighter relationship between the Fed and the Treasury regarding bond market policy.