Warsh advocates for a nuanced Fed policy: simultaneously cutting interest rates while passively shrinking the balance sheet by letting bonds mature. This "passive quantitative tightening" aims to reduce the Fed's market footprint without the shock of active selling, representing a middle ground between aggressive easing and hawkish tightening.

Warsh contends that post-crisis quantitative easing primarily inflated asset prices (stocks, housing) rather than stimulating the real economy through traditional credit channels. This created a system where sophisticated investors profited by "playing the game," while wage earners lagged behind, questioning the policy's efficacy and fairness.

The post-Powell Fed is likely to reverse the QE playbook. The strategy will involve aggressive rate cuts to lower the cost of capital, combined with deregulation (like SLR exemptions) to incentivize commercial banks to take over money creation. This marks a fundamental shift from central bank-led liquidity to private sector-led credit expansion.

Recent increases in funding market spreads suggest banking reserves may be too restrictive. This puts pressure on the Federal Reserve to end its balance sheet runoff (QT) sooner than its official timeline, creating a potential for market disappointment if the Fed delays its decision.

Kevin Warsh argues the Fed has experienced "scope creep" by taking on quantitative easing, broad bank regulation, and social initiatives. He advocates for a return to a narrow mandate focused on price stability, using interest rates as the primary tool and exiting non-conventional mechanisms.

The Fed has a clear hierarchy for managing liquidity post-QT. It will first adjust administered rates like the Standing Repo Facility (SRF) rate and use temporary open market operations (TOMOs) for short-term needs. Direct T-bill purchases are a more distant tool, reserved for 2026, as the system is not yet at 'reserve scarcity'.

The Fed uses qualitative terms like "ample," "abundant," and "excess" to describe bank reserve levels without providing concrete, numerical definitions. This linguistic ambiguity allows for policy flexibility but creates uncertainty for market participants trying to precisely gauge the central bank's stance.

The impending halt of the Fed's balance sheet reduction (QT) is not a reaction to a major economic crisis, but a technical necessity to prevent stress in short-term funding markets as bank reserves become scarce. The Fed is preemptively avoiding a 2019-style repo spike, signaling a quiet return to mild balance sheet expansion.

The Fed's "ample reserve" system has fundamentally changed the Fed funds market. Banks no longer need to borrow reserves from each other. The market is now dominated by non-U.S. banks borrowing from home loan banks in a simple arbitrage trade, making it a poor barometer of liquidity.