Overview

Deutsche Bank’s global head of FX research, George Saravelos, argues that a Federal Reserve strategy focused on shrinking its balance sheet rather than raising policy rates would be a decidedly bearish development for the U.S. dollar. The commentary was published by Reuters on 20‑07‑2026, authored by Anuron Mitra.

Fed Balance‑Sheet Context

The Federal Reserve, under its new chair Kevin Warsh, turned hawkish last month, with at least half of the 18 FOMC participants penciling in at least one interest‑rate hike for the year in the updated dot‑plot. Warsh has repeatedly stressed the Fed’s commitment to price stability and has launched a sweeping review of monetary‑policy operations. In addition to rate hikes, the Fed can tighten monetary policy by reducing the money supply. The balance sheet currently stands at roughly $6.7 trillion, down from a 2022 peak of about $9 trillion.

Deutsche Bank Viewpoints

  • Balance‑sheet tightening alone is not bullish: Saravelos notes that without higher front‑end yields, balance‑sheet reduction does not lift a currency, citing the record lows in the trade‑weighted yen as evidence that “bear steepening” of the U.S. yield curve is less supportive of the dollar than a flattening curve.
  • Potential policy conflict: He warns that a focus on balance‑sheet reduction could clash with the U.S. administration’s objective of keeping long‑end yields low, drawing a parallel to the Bank of Japan where aggressive QT has raised concerns about central‑bank independence and prompted the Japanese finance minister to discuss using domestic savings to defend JGBs.
  • Fed’s Treasury holdings are not unusual: By some metrics, the Fed’s ownership of U.S. Treasuries is comparable to other central banks, leading Deutsche Bank to doubt that the balance sheet is excessively large or that its reduction would be an effective anti‑inflation tool. Nonetheless, a shift from rate hikes to balance‑sheet tightening would be viewed as a bearish signal for the dollar.

Market Indicators

The U.S. dollar index, which measures the greenback against a basket of six major peers, last settled at 100.77. Meanwhile, the Japanese yen has recently touched a four‑decade low against the dollar and has remained above the levels that triggered intervention by Tokyo earlier in the year.

Additional Context

Saravelos points to the Bank of Japan’s record‑high pace of liquidity withdrawal—allowing a large amount of JGBs to roll off its balance sheet as they mature—as a precedent for assessing the Fed’s potential QT impact. He emphasizes that the BoJ’s aggressive QT is far more pronounced than that of other G10 economies.