By Karishma Vanjani

Kevin Warsh pitched cutting interest rates before his nomination, and later used the confirmation hearing to call for shrinking the Federal Reserve's massive $6.7 trillion balance sheet. The newly installed chairman of the Fed is unlikely to do either in his early days.

The U.S. spends close to $2 trillion more than it collects each year. The people plugging this shortfall are buyers of U.S. debt. They are getting impatient with the Fed's inability to control inflation that has contributed to rising yields and sinking bond prices.

Inflation is running at close to double the Fed's stated 2% goal. War in Iran, along with President Donald Trump's penchant for tariffs, has sparked renewed inflation fears by lifting prices for energy and imported goods.

Against such a backdrop, enters Warsh, who sees the advent of artificial intelligence as a solution to inflation. The argument is AI would lower labor costs for businesses while boosting output. It is a rhetoric likely to irk bondholders.

"To get the job, obviously, Warsh made this argument that there is a productivity revolution in place," said Brij Khurana, fixed-income portfolio manager at Wellington Management. "It would be concerning to the bond market if that's the focus of his discussion compared to talking about shorter term inflation being a risk."

He needs to "create like a bona fide inflation-fighting mind-set," Khurana added.

The market has already begun pricing in the probability that the Federal Reserve will move to lift short-term interest rates later this year and next year. Higher rates are bad for bonds. But higher short-term rates -- if bondholders are convinced they mean that the Fed is moving aggressively to crimp inflation -- could result in lower long-term rates, which the bond market would welcome.

The 30-year Treasury bond, currently yielding 5.014%, last month hit its highest yield since the global financial crisis some 20 years ago. Rising yields offer a chance for new investors to jump in, but existing investors get dinged as their older lower-yielding bonds decline in value. Higher rates also raise mortgage, credit-card and other borrowing costs.

Treasuries, and their demand, isn't Warsh's mandate. It's Treasury Secretary Scott Bessent's business. But the trajectory of interest rates, set by the Federal Open Market Committee (FOMC), has a direct impact on the world's biggest sovereign market.

Warsh, at his Senate confirmation, said he prefers a measure of inflation called "trimmed averages" that kicks out the most extreme price gains and losses. The Dallas Fed's version of this metric removed things like an abnormal gain in fresh vegetable prices and clocked in a 2.35% rise for April on an annualized basis -- 0.94 percentage points lower than the Fed's traditional inflation measure: the core personal consumption expenditures price (PCE) index. It is the largest gap between the two inflation measures in over four years.

The trimmed averages exclude the supply-side price shocks triggered by Iran war. Critics say they ignore the reality of a postpandemic world where businesses have learned how to quickly pass on costs to consumers.

Leaning heavily on trimmed averages runs the risk of underestimating

inflation, just as the Fed did in   2021. A year later a popular-long-term bond fund, iShares 20+ Year Treasury Bond exchange-traded fund or TLT, posted a negative 31% return that year. 

Over $6 billion of money has been pulled out of TLT so far this year, more than the $3.2 billion outflow in the full calendar year of 2025. The fund is down 0.8% year to date while stocks are up 6.7%.

What can "calm nerves for longer tenors, and would present a best-case scenario for him" is if Warsh adopts a bias toward hiking or keeping rates stable in the future, Padhraic Garvey, head of global rates and debt strategy at ING says.

Warsh and his Fed colleagues can't be tied down to prior positions on inflation given we are in the midst of three supply shocks -- tariff, immigration and energy, says Priya Misra, Core Plus Bond ETF portfolio manager at J.P. Morgan. "Acknowledge that if inflation facts change, they change their mind."

Inflation, of course, is just one threat for the market. The other is strong U.S. economic growth, which encourages investors to bet on riskier SpaceX-like stocks and shun safe assets such as Treasuries. Enthusiasm on AI, pushing corporate profits to a record, is helping the economy -- and so is large government expenditure.

The U.S. government uses debt to finance some of this growth. Over the first roughly 500 days of Trump's second term, a net $2.3 trillion worth of Treasuries have been issued; That compares with $2.1 trillion over the same period during President Joe Biden's administration and $1 trillion during the first 500 days of Trump's first term.

Warsh chairs a central bank that owns $4.36 trillion worth of Treasuries and is among the largest debtholders globally. He wants to lighten the load. As long as the Fed remains a big source of debt demand, investors can't know the true cost of the nation's debt.

If the Fed steps back as a bond buyer, yields are likely to rise and prices to fall. The Fed could be compressing the 10-year yield by roughly one percentage point as of April, says Ed Al-Hussainy, portfolio manager at Columbia Threadneedle Investments, citing a 2022 model developed by Kansas City Fed researchers. Warsh has been a critic of the big Fed balance sheet for years, but he is unlikely to do much about it early on. If the Fed sheds Treasures, it risks triggering a market panic if the process isn't carefully calibrated and communicated. And while Warsh is chair he would also need to build a consensus within the 12-member FOMC before attacking the balance sheet.

Wall Street wants to see whether Warsh can handle the pressures of the job. Its unlikely he "would want to do anything that threatens financial stability, particularly so soon after assuming office," wrote Dario Perkins, global macroeconomist at TS Lombard.

For now inflation is front and center for the world's most important central banker.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com.

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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June 10, 2026 17:02 ET (21:02 GMT)

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