NextFin News - Peter Tchir, head of macro strategy at Academy Securities, says Federal Reserve Chairman Kevin Warsh should launch an Operation Twist-style maneuver - selling short-term Treasuries and buying long-term ones - to shrink the central bank's $6.76 trillion balance sheet without pushing long-term yields higher. The argument, made in a television interview on Aug. 20, arrives as the 30-year Treasury yield trades above 5.2%, its highest level since 2007, and it frames the defining tension of the Warsh Fed: how to unwind a balance sheet that is nearly eight times its pre-2008 size without breaking the long end of the bond market.
The proposal is a judgment about which part of the yield curve should absorb the pain of normalization. Warsh has made clear he wants the balance sheet smaller - "Because you have higher inflation caused by the bigger balance sheet, we wanna shrink that," he said in a Hoover Institution discussion earlier this year. Tchir's point is that the route matters as much as the destination. Let the long end roll off, and mortgage rates and corporate borrowing costs spike. Sell the short end and buy the long end, and the balance sheet shrinks while the term premium is contained. Operation Twist is the least-bad path available - and it is far from safe.
The Setup: A $6.76 Trillion Balance Sheet Meets a Fragile Long End
The Fed's consolidated balance sheet stood at $6.760 trillion as of Aug. 12, 2026, according to the central bank's H.4.1 statistical release. Of that, $4.538 trillion is held in U.S. Treasury securities, and the maturity mix is heavily weighted to the long end: roughly $1.616 trillion in securities with more than 10 years remaining, against about $999 billion maturing within one year. The System Open Market Account's weighted-average years to maturity is 14.56 - a legacy of more than a decade of quantitative easing that Warsh, who took office on May 22, inherited intact.
Before the financial crisis, the Fed's balance sheet was about $870 billion. It peaked near $8.9 trillion in 2022. The normalization question is not whether it comes down - Warsh has been a long-time critic of large-scale asset purchases, calling QE "reverse Robin Hood" - but how.
The market is already pricing stress at the long end. The 10-year Treasury yield was 4.65% on Aug. 19, and the 2-year yield was 4.17%, leaving a 48-basis-point 10-2 spread. The front end is anchored by expectations that the Fed holds its 3.50%-3.75% target range: federal funds futures imply a 71% probability of no change at the Sept. 16 meeting and a 29% probability of a 25-basis-point increase. The 10-year-minus-3-month spread was 79 basis points. The long end, however, is not behaving like a normal cycle. The 30-year yield above 5.2% is not a reaction to this month's inflation print; it is a repricing of who will finance the U.S. government, and at what price.
What Operation Twist Would Actually Do
Operation Twist is a balance-sheet-neutral maneuver: the Fed sells, or lets mature without reinvestment, short-term Treasury securities and uses the proceeds to buy long-term Treasuries. The size of the balance sheet does not change; its duration rises. The name comes from the shape it imprints on the yield curve - short rates up, long rates down, the curve "twisting" flatter. The Fed ran it twice: first in 1961, and again in 2011-2012, when the FOMC announced in September 2011 that it would purchase $400 billion of longer-term Treasuries to replace an equivalent amount of shorter-term securities, later extended to a total of $667 billion of short-term sales through 2012.
The mechanism is a portfolio-balance channel. By removing duration from private hands at the long end, the Fed compresses the term premium - the extra yield investors demand for holding long-dated risk. Research by Eric Swanson at the San Francisco Fed estimated the 2011-2012 operation lowered long-term rates by about 13 to 16 basis points. The point is not that 15 basis points saves the economy; it is that the effect is targeted. Quantitative easing expands the balance sheet and floods reserves; Operation Twist reshapes the curve at a fixed size. For a chairman who wants a smaller balance sheet and contained long-term rates at the same time, it is the only tool that delivers both.
But there is a catch the proposal has to confront. Selling short-term Treasuries - or letting them roll off - increases the supply of bills and short notes that private investors must absorb. In 2011, short rates were pinned at zero and the front end could not go lower; today, the front end is where the market is actively pricing the policy path. An Operation Twist under Warsh would be pushing short-term supply into private hands while the Fed signals a steady rate path. The two are not naturally aligned.
Why the Long End Is the Real Problem
The long end of the curve is not expensive because investors expect inflation to run hot next quarter. It is expensive because the supply of duration is structural and the buyer of last resort is leaving the market. The U.S. fiscal deficit is projected at 7.3% of GDP in 2026 and 2027, according to Fitch Ratings' baseline forecast. The Treasury is issuing record amounts of long-dated debt. And the Fed - the largest marginal buyer of the past 15 years - is now a net seller.
This is a regime shift, not a cycle. A cyclical move in long yields would be driven by a transitory shock - an oil spike, a hot monthly CPI print, a temporary liquidity squeeze - and it would mean-revert once the shock passed. The evidence points the other way. First, the driver is the supply of duration, which is set by multi-year fiscal policy rather than the business cycle. Second, the buyer side has changed structurally: the Fed's balance sheet is shrinking from its 2022 peak, and there is no new institutional buyer large enough to replace it. Third, the policy framework itself is in flux - a new chairman is overhauling Fed communications and balance-sheet policy, and markets are demanding a fresh risk premium for that uncertainty.
Warsh has been explicit about his direction of travel. At the Hoover Institution he said the Treasury and the Fed need "to come to some accord, much like the treasury and the Federal Reserve came to in 1951" - a reference to the Treasury-Fed Accord that freed the central bank to set interest rates. That sentence is the key to the whole debate. Warsh wants the balance sheet smaller, but he also knows he cannot do it "overnight." Operation Twist is the compromise: shrink the balance sheet's footprint on the long end while shrinking its size gradually.
The Second-Order Risk: Front-End Plumbing
Here is the consequence the market is not fully pricing. Operation Twist shifts the duration burden from the long end to the short end. The Fed stops being a buyer - or becomes a seller - of bills and short notes. That paper has to go somewhere: money-market funds, banks, primary dealers. If the Treasury is simultaneously issuing record bills to fund the deficit, the front end can become crowded. Crowded front ends break in plumbing, not in headlines.
The analog is September 2019, when overnight repo rates spiked to as high as 10% because reserves were scarce and Treasury issuance flooded the market. The Secured Overnight Financing Rate jumped from 2.43% on Sept. 16 to 5.25% on Sept. 17, and the effective federal funds rate moved above the top of the Fed's target range. The Fed had been shrinking its balance sheet quietly - "like watching paint dry," as Janet Yellen put it in 2017 - until the plumbing seized. The fix was to restart Treasury purchases.
An Operation Twist under Warsh would be deliberately engineering a similar supply shift at the front end, only this time with a fiscal deficit of 7.3% of GDP - well above the 4.6% of GDP recorded in fiscal 2019 - and a banking system under tighter liquidity-coverage requirements. The transmission chain runs: Operation Twist announced -> long-term supply absorbed by the Fed -> term premium compresses, 10-year and 30-year yields fall -> short-term supply pushed into private hands -> bill market crowded -> overnight funding rates rise -> if reserves fall below banks' required buffers, repo volatility returns -> the Fed is forced to choose between its balance-sheet target and market stability. The second-order effect is not a yield move; it is a liquidity event. And liquidity events do not announce themselves until they arrive.
The Counter-Case: Let the Long End Roll Off
The strongest argument against Tchir's call comes from the other side of the same trade. Analysts at ABN AMRO have outlined a "Reverse Operation Twist" scenario in which the Fed lets long-term holdings run off toward market-neutral duration, accepting higher long-term yields as the price of normalization, while the Treasury offsets the impact by shifting its own issuance toward shorter maturities - in effect conducting its own Operation Twist to counter the Fed's. The logic is clean: if the goal is a smaller, shorter-duration balance sheet, then selling the long end is the direct route, and the Treasury can manage the term-premium fallout through issuance policy.
This counter-thesis attacks Tchir's premise at its foundation. It says the term premium is not something the Fed should be suppressing - it is the market's correct price for fiscal risk, and suppressing it distorts capital allocation and delays the fiscal adjustment. ABN AMRO notes that of the roughly $691 billion of Fed-held government debt maturing in 2026, only about $12 billion sits in the 20-30 year bucket, meaning a passive roll-off is already heavily weighted to the short and intermediate end. In that reading, Tchir's Operation Twist is an unnecessary intervention that props up the long end for a chairman who has explicitly argued against propping up asset prices.
The counter-thesis has force, but it rests on one assumption: that the Treasury will in fact coordinate its issuance with the Fed. That is a big assumption. A 2026 Fed-Treasury accord is possible - Warsh himself invoked 1951 - but it is not guaranteed, and Treasury issuance decisions are set by cash-management needs and political constraints, not by the Fed's preferred duration profile. Without that coordination, a passive long-end roll-off simply hands the term premium to a market that has already signaled it wants more of it. The 30-year yield above 5.2% is that signal, in real time.
What to Watch: The Signals That Decide the Trade
The debate between Tchir's twist and the roll-off alternative will be resolved by observable data, not rhetoric. Three signals matter.
First, the term premium itself. If the 10-year yield falls below 4.25% while the balance sheet continues to shrink, that would validate the view that the long end was pricing policy uncertainty rather than fiscal fundamentals - and that a composition change can fix it. If instead the 10-year holds above 4.75% despite an Operation Twist announcement, the market is pricing fiscal risk that no composition tweak can reach, and the roll-off camp wins.
Second, money-market plumbing. If overnight repo rates trade above the top of the Fed's target range for five consecutive sessions, or if the effective fed funds rate persistently breaches the target, the front-end crowding thesis is firing and the twist is creating the liquidity stress it was meant to avoid. That was the 2019 lesson, and it is the falsifying signal for the Operation Twist trade.
Third, the fiscal backdrop. Fitch's deficit projection of 7.3% of GDP for 2026-2027 is the baseline. If the deficit trajectory bends down through spending cuts or revenue gains, the supply-of-duration argument weakens and the long-end selloff proves cyclical after all. If it holds or widens, the structural call stands.
The Outlook: Three Scenarios for the Warsh Balance Sheet
Base case: a delayed, partial Operation Twist. Warsh announces a balance-sheet composition shift in late 2026 or early 2027 - letting short-term holdings roll off and reinvesting in the five-to-10-year part of the curve, while allowing the overall balance sheet to drift lower. The 10-year yield settles in the 4.25%-4.50% range; the 30-year stays elevated near 5%. This is the compromise that splits the difference between Tchir's call and the roll-off camp.
Upside case: a full Fed-Treasury accord. Warsh secures the 1951-style coordination he invoked, the Treasury tilts issuance short, and the Fed executes a classic Operation Twist. Long yields drop 25-40 basis points, the curve steepens, and the balance sheet shrinks without a liquidity event. This is the bull case for duration - but it requires political coordination that has not existed in modern memory.
Downside case: twist fails, plumbing breaks. The front end crowds, repo rates spike, and the Fed is forced to pause balance-sheet reduction or restart purchases - a 2019 repeat on a larger fiscal stage. In that scenario, the long end rallies on safe-haven flows even as the Fed's credibility takes a hit.
Across time horizons, the picture splits. In the short term - the next one to two FOMC meetings - the front end is dominated by the rate path, and the 71% probability of a September hold keeps the 2-year anchored. In the medium term - six to twelve months - the balance-sheet composition decision is the swing factor for the 10-year. In the long term, the structural drivers dominate: deficits, debt supply, and whether the Fed can credibly commit to a smaller balance sheet without being forced back into purchases by a liquidity crisis.
The central judgment is this: Tchir is right that Operation Twist is the least-bad tool Warsh has, but he is not right that it is safe. It solves the long-end problem by creating a front-end one, and the front end is where central banks have historically been surprised. Warsh wants a 1951-style accord and a smaller balance sheet. The market is telling him, through a 30-year yield at a 19-year high, that it will charge for the transition.
"Because you have higher inflation caused by the bigger balance sheet, we wanna shrink that. We can't do it overnight. We want the Treasury Department and the Federal Reserve to come to some accord, much like the treasury and the Federal Reserve came to in 1951."
Kevin Warsh, speaking at the Hoover Institution earlier in 2026, captured the dilemma in one sentence. The question for markets is not whether Warsh shrinks the balance sheet - he has said he will. It is whether he can do it without the bond market forcing his hand first. Operation Twist may be the answer. It may also be the trap.
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