Federal Reserve Chair candidate Waller: Advocates for a moderate overall reduction of the balance sheet to $5.8 trillion, supports interest rate cuts as a "minority" view

According to the Zhitong Finance APP, Federal Reserve Governor Christopher Waller recently stated that the U.S. central bank should have the ability to gradually reduce bank reserves from the current $3.26 trillion to around $2.7 trillion. If the currency held by the Federal Reserve and the balance of the U.S. Treasury's general account are included in the calculation, the overall balance sheet size will shrink from the current $6.7 trillion to $5.8 trillion. As one of the potential candidates for the next Federal Reserve Chair under President Trump, Waller emphasized that the Federal Reserve should continue to advance the process of balance sheet reduction, but the extent need not be as aggressive as suggested by some observers and economists.

Waller pointed out at an event hosted by the Dallas Federal Reserve: "We may be able to continue reducing reserve balances by allowing some maturing and early-redeemed securities to naturally exit the balance sheet." He specifically mentioned that determining the minimum "adequate" reserve level is crucial for assessing the upper limit of balance sheet reduction, as this level directly relates to whether the overnight funding market will be disturbed. According to the latest data from the Federal Reserve, the current total reserves held by banks in the U.S. amount to $3.26 trillion, while Wall Street strategists estimate that to maintain market liquidity and avoid stress, reserve balances need to be kept in the range of $3 trillion to $3.25 trillion.

It is noteworthy that Waller advocates for clearly setting a specific value for "adequate" reserves, contrasting with the broader definitions previously used by institutions like the New York Federal Reserve. The latter tends to retain flexibility to respond to market changes when reserve balances decline. Additionally, Waller reiterated his belief that the federal funds rate is set too strictly and may support a rate cut at the next Federal Reserve meeting this month. He emphasized that this position is not politically motivated, even though it makes him a minority among his colleagues.

The Trump administration has recently called for the Federal Reserve to cut interest rates multiple times. Kevin Hassett, Director of the White House National Economic Council, criticized the Federal Reserve on Thursday for being "behind the curve" and not adjusting rates in sync with other central banks. In terms of balance sheet policy, some critics believe the Federal Reserve should restore its size to pre-financial crisis levels. During the 2008 crisis, quantitative easing policies caused the balance sheet to surge from about $800 billion to over $2 trillion. Potential candidates for the next chair, such as Kevin Warsh, also belong to this critical camp.

Waller further proposed that the Federal Reserve should increase the proportion of short-term assets in its balance sheet, with long-term securities used only to hedge monetary liabilities or to account for about half of U.S. Treasury holdings. In response to some market participants suggesting that "the Federal Reserve's asset composition should mimic the U.S. Treasury market, setting the proportion of short-term assets at 20%," Waller believes that while this plan could avoid pressure on the yield curve, it would extend the duration of the balance sheet and increase the risk of potential income loss for the Federal Reserve, as seen in recent years