U.S. Federal Reserve Chair Jerome Powell

made a revealing comment last week: “If our ability to pay interest on reserves and other liabilities were eliminated, the Fed would lose control over rates.” While he acknowledged that the Fed’s net interest income has temporarily turned negative due to the rapid rise in policy rates, he emphasized this is “highly unusual” and expects it to return to positive territory soon.

Still, the admission is striking as it underscores how the Fed’s control over monetary policy now hinges on artificial mechanisms like interest on reserves, rather than traditional market dynamics. This shift raises important questions about the sustainability and independence of rate-setting in a system increasingly reliant on engineered tools.

Here’s why that matters: The Fed has pumped so much money into the banking system that banks now have more cash than they need. So instead of borrowing from each other, they just park their excess money at the Fed, which pays them interest. This means the usual market for overnight bank lending has dried up.

As a result, the Fed isn’t just influencing interest rates anymore, it’s setting them directly by deciding how much interest to pay on reserves. That’s what Powell means when he says the Fed would lose control if it couldn’t pay interest: without that tool, there is no longer a functioning market to naturally set rates. The Fed has effectively become the market.

This marks a fundamental shift. Powell’s comment confirms what many have long suspected: the system is too fragile to return to the days of old. The Fed’s balance sheet has grown so large that shrinking it without triggering financial instability is no longer feasible. The U.S. central bank has essentially trapped itself, just like the U.S. federal government, which can’t roll back pandemic-era spending without political and economic fallout. The system expands, then insists it can’t contract without causing harm. That’s simply not sustainable, and the rally in

gold markets

is telling you this much.

When Powell says we “may be approaching the end of balance sheet contraction in coming months,” he is not declaring success. He is signalling that the illusion of control is fading. The financial system has become so dependent on liquidity that pulling it back risks breaking key components, including credit markets.

Treasury demand and the shadow banking system

Since 2008, every expansion of the Fed’s balance sheet has been a rescue mission not just for liquidity, but also for confidence. Every attempt to shrink it has tested whether the system can stand on its own. It can’t. The

U.S. economy

is now fully addicted to easy money. Trying to unwind that addiction risks collapsing

gross domestic product

(GDP), tax revenues, pensions, housing prices and equity markets — all at once.

The Fed’s balance sheet no longer moves in predictable cycles, it ratchets upward with each crisis. Instead of returning to previous levels, every intervention sets a new baseline. The 2008 financial crisis introduced permanent risk insulation, the pandemic response in 2020 cemented it and now, in 2025, the Fed is quietly acknowledging that this elevated baseline isn’t temporary; it has become the new foundation of the economy.

This isn’t just about interest rates or balance sheet size. It’s about trust and how quickly that trust is eroding. The belief that the Fed can safely withdraw support is cracking. This round of quantitative tightening (QT) has already stalled regional bank lending, drained liquidity from the Treasury market and triggered a quiet funding crisis.

We’re now in a strange place: The economy doesn’t guide the Fed anymore; instead, the Fed’s own beliefs guide the economy. That’s why markets often move before policy does, as gold rallies, bitcoin tightens and real assets react before the Fed even speaks.

Powell’s words are a quiet confession: Tightening now causes more damage than easing can fix. The “end of balance sheet contraction” isn’t a strategy, it’s surrender. Whatever the Fed calls its next move — “liquidity support,” “market operations” or “temporary QE” — it will be another expansion. Because the alternative is collapse.

But the worst part is that the Fed isn’t acting alone. When it chose to shrink its balance sheet through runoff — letting bonds mature — instead of outright sales, it handed control of financial conditions to the Treasury. Janet Yellen understood this, and Powell enabled it. The Fed’s policy committee continues to let the Treasury keep conditions loose.

Meanwhile, the Fed’s reinvestment policy has quietly added US$200 billion in long-term Treasuries even as it claims to be shrinking its balance sheet. If the Fed stopped buying these long-dated bonds, the Treasury would have to sell them to the public, exposing the scale of the debt and likely shaking asset prices.

But policymakers won’t act. They fear the

bond market

. Powell even joked that talking about the balance sheet is worse than going to the dentist. Of course it is, because the truth hurts.

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The Fed’s next move may not be about managing inflation or guiding the economy, it could be more about preserving the illusion that it still holds the reins. But illusions don’t last forever. Eventually, the public and markets wake up. And when they do, they’ll realize the real risk isn’t volatility, it’s the false confidence that central banks are still fully in control, even as their influence relies more on engineered mechanisms than genuine market dynamics.

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc., operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning. The opinions expressed are not necessarily those of Wellington-Altus.

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