National Bank of Canada’s Taylor Schleich and Ethan Currie say the Federal Reserve has limited room to shrink its balance sheet much further under current rules. The balance sheet is about $6.5 trillion after earlier quantitative tightening (QT).
They say the Fed’s liabilities determine the size of its assets. The main constraints are bank reserves and the Treasury General Account (TGA). Demand for currency also tends to rise as the economy grows, which supports a larger base of liabilities.
Constraints On Further Balance Sheet Reduction
They argue that meaningfully reducing reserve demand would likely require regulatory changes. Those changes could let banks hold more Treasuries and allow a smaller Fed portfolio. They also note a risk: if Treasuries move from a stable holder to less stable holders, market risk could increase.
They do not expect QT to restart, aside from small tweaks to how the Fed reinvests maturing securities. Since QT ended, they note that outright Treasury purchases have been mostly limited to Treasury bills, which has shortened (reduced the duration of) the Fed’s holdings.
Overall, the Fed appears to have very little room to shrink its balance sheet below the current $6.5 trillion level. Key liabilities—such as bank reserves, which have stabilized around $3.3 trillion, and a persistently high TGA—limit how far the Fed can go. This suggests the period of major QT that ended in 2025 is likely over.
Without deregulation that reduces banks’ need to hold reserves, any further asset sales could trigger funding-market stress. The repo market spike in September 2019 showed what can happen when reserves get too scarce. The Fed will likely prefer a large balance sheet over a repeat of that kind of volatility.
Implications For Volatility And Curve Positioning
For derivatives traders, this view suggests one major source of system-wide tightening is no longer in play, which could keep long-term volatility lower. The VIX has already drifted down, trading in a narrow 13–15 range through January 2026. That backdrop can favor “calm-market” strategies, such as selling strangles on major indices or shorting VIX futures.
We also expect the Fed to keep managing portfolio duration by reinvesting into T-bills, a strategy it used in late 2025. This could add mild, steady steepening pressure on the yield curve. Traders could express that view with SOFR futures by positioning for longer-term rates to rise relative to shorter-term rates.
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