Walsh supports it, far-reaching impact! After 75 years, is the Federal Reserve going to reach an agreement with the U.S. Treasury again?

With Trump nominating Walsh as the next Fed Chair, one of his core long-held proposals is drawing heightened attention from Wall Street: calling for the Federal Reserve and the U.S. Treasury to reach a new agreement to reshape the relationship between the two institutions. This plan aims to emulate the historic 1951 Accord, which could impact the $30 trillion U.S. Treasury market and fundamentally change the Fed's balance sheet management.

On February 9, according to Bloomberg, though details have not yet been released, Walsh has previously stated that such an agreement should "clearly and thoughtfully describe" the Fed's balance sheet size, and coordinate with the Treasury's debt issuance plan. At the same time, U.S. Treasury Secretary Bassent holds doubts about long-term quantitative easing (QE), arguing it should be used only in emergencies and under government coordination.

The report notes that the debate among market participants centers on whether this is just a bureaucratic tweak or a major overhaul of the Fed's over $6 trillion securities portfolio. If it involves large-scale portfolio adjustments, it could trigger increased volatility in the $30 trillion U.S. Treasury market and raise profound concerns about central bank independence.

Notably, the annual interest cost of current U.S. government debt is about $1 trillion, intensifying speculation that the Fed may assist fiscal financing with some form of “yield curve control,” directly affecting inflation expectations and the attractiveness of dollar assets.

Return to 1951? Walsh’s Policy Proposal

According to reports, among the many proposals Walsh put forward during his campaign for Fed Chair, none is as cryptic yet consequential for Wall Street as his call for a new accord with the Treasury. Walsh has publicly supported thoroughly reforming the relationship between the two agencies by reintroducing a new version of the “1951 Accord.”

The historic 1951 Accord greatly restricted the Fed's footprint in the bond market, established central bank autonomy in monetary policy, and ended the wartime and postwar practice of the Fed suppressing Treasury yields to lower federal borrowing costs.

However, Walsh pointed out last April that the Fed’s multitrillion-dollar securities purchases during the financial crisis and the pandemic actually violated 1951’s principles. In interviews and speeches, he argued that these actions encouraged reckless government borrowing.

Walsh said in a CNBC interview that a new accord could clearly define the size of the Fed’s balance sheet, while leaving the Treasury to determine its debt issuance plans.

Bassent’s Position and “Soft Veto Power”

The report notes that Treasury Secretary Bassent and Walsh share skepticism toward prolonged QE. Bassent has accused the Fed of persisting with QE for too long, disrupting the market’s ability to send key financial signals.

As the key person responsible for selecting Powell’s successor, Bassent advocates for the Fed to implement QE only in “truly emergency situations” and in coordination with other government agencies.

Thus, a “streamlined” new accord might stipulate that apart from routine liquidity management, the Fed could conduct large-scale Treasury purchases only with Treasury approval and should aim to end QE as soon as market conditions allow.

However, Krishna Guha of Evercore ISI points out that such a setup, by involving the Treasury in Fed decisions, may lead to other interpretations. Investors may see this as Bassent having “soft veto power” over any quantitative tightening (QT) plans.

Portfolio Shift: From Bonds to Bills

Beyond policy framework adjustments, the market widely expects that a more substantive agreement may entail a major shift in the Fed’s asset holdings—from medium- and long-term securities to Treasury bills (T-bills) with maturities of 12 months or less.

Such a shift would allow the Treasury to reduce the issuance of notes and bonds, or at least not increase issuance as previously planned.

In its quarterly debt management statement last Wednesday, the Treasury has already linked the Fed’s actions to its own issuance plans, stating it is closely monitoring the Fed’s recent increased purchases of T-bills.

Jack McIntyre of Brandywine Global remarked: “We are already on a path of closer coordination between the Fed and Treasury; the question is whether this coordination will be amplified further.”

According to reports, strategists at Deutsche Bank predict that under Walsh, the Fed may become an active buyer of T-bills over the next five to seven years. In one scenario, they expect the proportion of T-bills in the Fed’s portfolio could rise from less than 5% to 55%.

However, if the Treasury shifts towards selling T-bills instead of interest-bearing securities, it faces the risk of rolling over huge amounts of debt, potentially increasing volatility in borrowing costs.

Market Risks and Independence Concerns

The report says that while enhanced coordination may aim to lower American borrowers’ interest costs, any fundamental shifts carry risks. Tim Duy, chief U.S. economist at SGH Macro Advisors, warns:

An agreement publicly synchronizing the Fed’s balance sheet with Treasury financing, explicitly linking monetary operations with deficits, is less about isolating the Fed and more akin to a yield curve control framework.

Ed Al-Hussainy, portfolio manager at Columbia Threadneedle Investments, is more direct: If the deal implies the Treasury can count on the Fed buying certain debt or portions of the yield curve in the foreseeable future, “that would be extremely, extremely problematic.”

The worst-case scenario is investors believing the Fed’s actions have diverged from its anti-inflation mandate, driving up volatility and inflation expectations, and possibly undermining the dollar’s attractiveness and the safe-haven status of U.S. Treasuries.

Some Doubt the Likelihood of a Formal Accord

Beyond the Treasury market, some experts have proposed broader scenarios. Guha of Evercore ISI has floated the idea of the Fed swapping its $2 trillion mortgage-backed securities (MBS) portfolio for Treasury bills with the Treasury.

While this faces many obstacles, one goal could be to lower mortgage rates—a Trump administration priority. Former Fed Vice Chair Clarida wrote that a new accord could offer a framework for the Fed, Treasury, and even housing agencies like Fannie Mae and Freddie Mac to coordinate, shrinking their balance sheets.

However, Mark Dowding, Chief Investment Officer at RBC BlueBay Asset Management, believes Walsh will likely seek to preserve Fed independence: “This does not preclude greater cooperation, but it lowers the likelihood of a formal agreement.”

George Hall, Professor of Economics at Brandeis University, warns that direct coordination to lower interest costs “may work for a period,” but over the long term, investors have alternatives to U.S. assets.

“People will find ways around it, and over time, they’ll move their money elsewhere.”

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