Asset implications of narrow QE

Steven Abrahams | April 10, 2026

This material is a Marketing Communication and does not constitute Independent Investment Research.

Imagine a Fed that holds a much smaller portfolio than it does today and traffics only in Treasury bills and short notes, the days of holding longer debt and MBS over. With Kevin Warsh, a steady critic of QE and large Fed portfolios, nominated to succeed Jerome Powell as Fed chair next month, this possibility may get more attention. A recent speech by Dallas Fed President Lorie Logan suggests it already is. The Fed’s own work suggests it would mean higher rates and wider MBS spreads.

The QE critics

Warsh has argued that QE went too big and lasted too long, allowing the federal government to spend without worrying enough about the risk of higher interest rates. In a Wall Street Journal opinion piece last November, he called the Fed balance sheet “bloated.” He has not spelled out the best way to reduce the Fed portfolio, manage the impact on bank reserves and the financing markets or the alternatives if the Fed ever finds itself again with fed funds near zero. Nevertheless, there may be reasonable choices on all these fronts.

Others, including John Cochrane of the Hoover Institution, have been more specific in arguing the Fed has stepped over the line dividing monetary and fiscal policy. The Treasury should be responsible for determining the maturity structure of government debt, this school points out, but QE has distorted this by buying debt all along the yield curve and then replacing it with overnight debt in the form of reserves that pay interest. The Fed should stay out of the maturity business, this school contends, by buying only Treasury bills or short debt or by creating reserves through collateralized lending like the Bank of England or the European Central Bank. This set of critics also urges the Fed to get out of the business of allocating credit through its purchases of MBS. This line of thought is much less focused on the size of the Fed balance sheet than on its composition. By crossing the monetary-fiscal line, the Fed has risked entangling itself in fiscal politics, perhaps no better demonstrated, at least since 1951, by the events of the last year.

Dallas Fed President Logan’s speech

With QE critics in the background, the Dallas Fed’s Logan delivered an April 2 speech focused entirely on ways to shrink the Fed balance sheet. Logan managed the Fed’s portfolio when she worked at the New York bank, so she has lived QE up close. She noted a big balance sheet is not bad if it serves the public, but too large a portfolio could come at a cost if it becomes “a distraction from our mission,” possibly an echo of critics umpiring the monetary-fiscal line.

The speech draws from an essay Logan published the same day with her colleague Sam Schulhofer-Wohl that runs through a range of ways to reduce balance sheet liabilities—currency, the Treasury General Account and bank reserves now the largest components. The speech does not address the asset side of the balance sheet although the essay notes that “changing the size of Fed liabilities would also change the quantity of assets that the Fed holds to back its liabilities.” The essay then acknowledges the issues highlighted by Cochrane, noting “Fed asset holdings can influence both term premiums in financial markets (by changing the amount of duration risk that remains in the hands of private investors) and the duration risk facing taxpayers (by changing the consolidated government balance sheet).”

The essay also leans in the direction of the Fed only holding very short assets, treating “each Fed liability as if it were backed by assets of equivalent duration.” Since the biggest current liability is overnight reserves, that presumably implies investment only in very short Treasury debt.

Logan’s speech signals that the Fed is looking at ways to shrink its balance sheet, change the asset composition or both.

Implications for rates and MBS spreads

Warsh would have to persuade his colleagues on the FOMC that the Fed can change the size and composition of the balance sheet without risking damaging instability in funding, payments or banking. If the FOMC agrees, it would likely take a long time for transition to play out. But the news could affect asset prices long before change becomes fact.

Work by the Fed’s own staff suggests QE along the yield curve and in MBS has had significant impact on rates and spreads. Analysis of the first round of QE in 2009, when the Fed bought $300 billion in Treasury debt, concluded it reduced longer-term Treasury yields by about 35 bp. Analysis of the second round from late 2010 through mid-2011, when the Fed bought $600 billion in Treasury debt, reduced longer-term yields by an estimated 45 bp. Other work done outside the Fed at the time had smaller estimates, but plausibly because of differences in methods. Work also done at the Fed on the impact of MBS purchases concluded that every 1% of outstanding MBS held by the Fed reduced MBS spreads by 2.3 bp.

A Fed decision to navigate toward a smaller or short-duration balance sheet presumably would not only unwind the effect of the current sheet on rates and spreads in a stable market but also expectations for future crisis. The return of QE at the outset of Covid—along with a wide set of special programs to support commercial paper, money market mutual funds, corporate and municipal debt and bank lending—likely persuaded some in the markets that the Fed would always backstop critical markets. A shift in approach to QE may lead investors to demand a bigger risk premium for future crisis.

Eyes on the paper trail

FOMC minutes and staff papers will likely be the thing to watch for clues to whether balance sheet policy is changing, although ultimately some more formal announcement would come. The clues should be enough to push longer rates up on the marginand spreads wider.

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The view in rates

Oil. Tariffs. Rising capital expenditure. Rising disposable income. Add to all of these the strong March payrolls and a decline in the unemployment rate, suggesting a steady if not strong labor market. The Fed has little if any room to move rates lower this year. The front end of the curve is probably stuck around current levels.

The 2s10s Treasury slope traded Friday at 51 bp, steeper by 1 bp over the last week, with 5s30s at 97 bp, steeper by 4 bp.

Key market levels:

• Setting on 3-month term SOFR traded Friday at 367 bp, nearly unchanged in the last five weeks
• Further out the curve, the 2-year note traded Friday at 3.78, lower by 6 bp over a week. The 10-year note traded at 4.32%, down by 2 bp.
• The Treasury yield curve traded Friday with 2s10s at 51 bp with 5s30s at 97 bp
• Breakeven 10-year inflation traded Friday at 237 bp, unchanged over the last week, with 5-year forward 5-year breakeven at 220 bp, signaling that confidence in the Fed target still holds. The 10-year real rate finished the week at 194 bp

The view in spreads

The US-Iran volatility has affected all risk assets with corporate debt also wrestling with concerns around private credit and AI. But the US ultimatums, invariably resolved, have encouraged investors to pull out the Liberation Day playbook. That playbook would anticipate slowly tighter spreads as the confrontation de-escalates.

Technicals are constructive for both MBS and corporate debt. Fixed income mutual funds and ETFs are getting steady inflows, creating a steady bid for both spread assets. Fannie Mae and Freddie Mac continue to add to their mortgage portfolios, and insurers continue to issue annuities and buy corporate and structured credit. Supply in MBS is relatively low, although gross and net issuance in corporate debt is likely to contribute to softer spreads in that asset as that market tries to accommodate debt to finance AI buildout.

The Bloomberg US investment grade corporate bond index OAS traded on Friday at 80, tighter by 3 bp on the week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 113 bp, tighter by 3 bp. Par 30-year MBS TOAS closed Friday at 20 bp.

The view in credit

Haves and have nots. Big companies have healthier balance sheets than smaller companies. Consumers at the middle-to-higher end of the income distribution also have liquidity and wealth. Bank lending to non-bank financial institutions, including private debt funds and business development companies continues to expand. Bank regulators continue to focus on that category of lending, which could eventually tighten the private credit markets. But for now, credit metrics for NBFI lending are strong relative to traditional bank lending such as C&I.