Summary of Key Points
Although the absolute size of the Federal Reserve’s balance sheet has reached $6.7 trillion (far exceeding the $900 billion in 2007), the proportion of U.S. Treasury bonds it holds in the total outstanding debt has decreased from 19% in 2021 to 11.2% (nearing the level of 2002). This contrast is due to the much faster growth in the total supply of U.S. Treasury bonds compared to the growth in the Fed’s bond holdings. The new Chairman Powell, facing a “trilemma” (small balance sheet, stable interest rates, and minimal market intervention), has abandoned the goal of reducing the balance sheet size and instead focused on structural adjustment: by swapping shorter-term bonds for longer-term ones, he aims to shift risks and achieve an implicit expansion while maintaining a certain proportion of Treasury bonds in the overall debt portfolio, ultimately reshaping the market’s pricing logic.
Detailed Analysis
1. Large Absolute Size, but Declining Proportion: The Expansion of Total Debt Dilutes the Fed’s Share
The absolute amount of Treasury bonds held by the Fed ($4.38 trillion) may seem substantial, but it cannot keep up with the rapid pace at which the U.S. government issues new debt. From 2021 to 2026, the total U.S. debt increased from $29 trillion to $39 trillion (a 34.5% increase), while the Fed’s holdings decreased from $5.5 trillion to $4.38 trillion (a 20.4% decrease). It’s like if you originally had 10 candies, accounting for 20% of the total 50 candies in the class; later, when the number of candies increased to 100, your share dropped to 15%. Although you have more candies, your proportion has decreased. This “passive dilution” provides the Fed with an excuse for its future actions: “I’m just following the overall trend of debt growth and not intervening much in the market.”
2. Powell’s Trilemma: Abandoning Balance Sheet Reduction to Maintain Stability and Minimize Intervention
The Fed faces three conflicting goals:
- A small balance sheet size;
- Low short-term interest rate fluctuations;
- Minimal market intervention.
It can only achieve two of these goals. Powell initially wanted to reduce the balance sheet, but by the end of 2025, there was a shortage of reserves in the money market (banks lacked sufficient funds for transactions), forcing him to abandon this goal and opt for options 2 and 3: implementing the Reserve Management Program (RMP) to buy shorter-term bonds, injecting cash into the market to stabilize interest rates while avoiding excessive intervention. As a result, the balance sheet remains at around $6.7–$6.8 trillion, but its internal structure has changed.
3. Swapping Short-Term for Long-Term Bonds: Shifting Long-Term Risks to the Market
The Fed holds too many long-term bonds—with an average maturity of 9 years (compared to 3 years before the financial crisis), and long-term bonds over 10 years account for 40%, while short-term bonds only account for 7% (previously 36%). Since long-term bonds have higher risks due to their longer maturities, Powell plans to swap them for shorter-term ones:
- Option One: Using the funds from maturing Mortgage-Backed Securities (MBS) to buy shorter-term bonds; the Fed has explicitly stated it will no longer purchase MBS and is withdrawing from the housing market.
- Option Two: Buying short-term bonds through the RMP on a monthly basis (currently $10 billion per month, with flexible adjustments).
By doing this, the Fed transfers the risks associated with long-term bonds to the private markets (banks, funds, etc.). To acquire these long-term bonds, markets have to pay higher interest rates, which in turn drives up the yields on long-term bonds.
4. Implicit Loose Policy: “Not Expanding” Officially, but Actually Increasing Monetary Supply
Powell’s strategy is clever in that he doesn’t explicitly claim to be implementing loose monetary policy; however, he is effectively expanding the balance sheet. By targeting a certain proportion of Treasury bonds (e.g., 11%-15%), the Fed’s bond holdings increase as the total debt grows. For example, if total debt increases by $1–2 trillion annually, the Fed’s holdings also increase, and although the proportion remains the same (with minimal intervention), the absolute size of its balance sheet expands. The RMP at the end of 2025 is a prime example: officially, it was about “maintaining reserves,” but in reality, it involved injecting cash into the market, which constitutes an instance of implicit quantitative easing.
5. Changing Market Conditions: Cheaper Short-Term Bonds, More Expensive Long-Term Bonds, and Steeper Yield Curves
These policies directly affect investors:
- Short-Term Bonds: With the Fed’s continuous purchases, demand for short-term bonds is high, driving up their prices and lowering their yields.
- Long-Term Bonds: Since the Fed does not renew long-term bond contracts, markets have to buy them at higher interest rates.
- Yield Curves: Lower short-term interest rates and higher long-term interest rates lead to steeper yield curves (i.e., a more upward slope). For instance, in June 2026, the yield on 2-year bonds increased by 13.9 basis points, while the yield on 30-year bonds decreased by 1.4 basis points, marking the beginning of this trend.
Additionally, the Fed’s “implicit intervention” continues: although it does not explicitly announce loose policies, its adjustment of bond holdings still affects the market. The “Fed put option” (a safety net for the market) remains in place, albeit in a different form.
Final Reminder
For individual investors, there’s no need to focus on the minor fluctuations in the balance sheet month by month. The important thing is to understand the Fed’s shift from “quantitative easing based on total debt growth” to “structural adjustment of the bond portfolio.” In the future, short-term bonds may become more stable, while long-term bonds may carry higher risks, and steeper yield curves will become the new norm. This represents one of the most profound changes in the U.S. Treasury market since 2008.