The historical 1951 Treasury-Fed Accord, which established the Federal Reserve's independence from the U.S. Treasury, is under renewed scrutiny as former President Donald Trump and his nominee for Fed Chair, Kevin Warsh, propose a new agreement. The original accord was created to stop the government from using the Fed to finance deficits, a practice that peaked during World War II when the Fed was forced to cap long-term bond yields at 2.5% and keep short-term rates at 0.375% to aid war financing, leading to post-war inflation and market instability.
Now, with Trump back in the White House, his pick for Fed Chair, Kevin Warsh, is floating the idea of a new written accord with Treasury Secretary Scott Bessent. Warsh's proposal aims to explicitly define the size of the Fed's balance sheet—currently over $6 trillion—and coordinate with the Treasury on debt issuance strategies. A core element of the plan involves shifting the Fed's portfolio away from long-term bonds and mortgage-backed securities towards short-term Treasury bills.
Deutsche Bank analysis suggests a Warsh-led Fed could increase its holdings of Treasury bills from less than 5% to as high as 55% over the next five to seven years. However, this shift is contingent on the Treasury issuing more short-term debt, which carries significant risk. Heavy reliance on bills would make government borrowing costs more volatile and susceptible to spikes in interest rates, potentially backfiring in unstable markets.
The debate centers on the Fed's independence. Trump has previously stated the Fed should be more mindful of how its policies affect the government's debt burden, with the U.S. currently paying nearly $1 trillion annually in interest. Former Fed Vice Chair Richard Clarida noted that Warsh's forward-looking, flexible approach could allow the Fed to better adapt to economic changes, but critics warn it risks returning to an era where monetary policy is dictated by fiscal needs. Wall Street is closely monitoring the situation, as a tighter Fed-Treasury link could fundamentally alter bond issuance, interest rate setting, and the central bank's autonomy.
