Barclays says Fed balance sheet reduction will take many years or may need rate cuts to offset tightening financial conditions.

Barclays strategists say that the transition to a smaller scale balance sheet by the Federal Reserve will require close coordination between the central bank and the Treasury Department to prevent excessive market volatility. They wrote that this process will lead to a tightening of the financial environment, and Kevin Warsh, the nominee for Fed chairman who has called for a significant reduction in the $6.6 trillion asset portfolio, may have to offset this tightening through lower policy rates. Barclays strategists Anshul Pradhan, Samuel Earl, and Demi Hu wrote, "Balance sheet normalization will be a multi-year process." They added, "Given Warsh's desire to shrink the balance sheet and the fact that the Fed and Treasury Department's goals are not always aligned, investors are likely to demand risk premiums during this transition process."