Decisions made by the Federal Reserve (the Fed, America’s central bank) have a profound influence on global financial markets. As a result, any change in leadership at the world’s most influential monetary institution could have significant implications for investors.
On 13 May, Kevin Warsh was confirmed by the US Senate as the next Fed Chairman. In this month’s commentary, we examine some of Warsh’s views and the changes he may seek to implement at the Fed.
Who is Kevin Warsh?
A former Morgan Stanley executive and White House economic advisor under George W. Bush, Warsh previously served as the youngest-ever Fed Governor from 2006 to 2011, playing a pivotal role during the 2008 financial crisis. As regards monetary policy, up until recently Warsh had a reputation as an inflation ‘hawk’ (i.e. someone who prioritises low inflation above other economic goals and generally favours higher interest rates), particularly after the Great Financial Crisis (GFC).
More recently, however, he has argued the case for cuts in interest rates, bringing his views more closely into line with President Trump, who nominated him for the post.
More broadly, Warsh has said there is a need for “regime change” in the conduct of policy by the Fed. In this regard, there are three key areas where changes under a Warsh Fed could have implications for investors: how policymakers communicate with markets; the size of the Fed’s balance sheet; and the measure of inflation that the central bank focuses on.
A less communicative Fed?
Over much of the past 25 years or so, the Fed has adopted several channels through which it communicates its thinking to the public. In 2011, the Fed Chair started giving regular press conferences, and the following year the so-called “dot plot” (a graphical representation showing individual policymakers’ forecasts for interest rates) was introduced.
After the GFC, the Fed increasingly relied on “forward guidance” as a policy tool, using communication about its likely future actions to shape financial conditions. In practice, this usually meant signaling that its policy rate would remain unchanged for an extended period in order to keep longer-term interest rates low.
Together with regular speeches from policymakers, these communication tools meant investors were rarely surprised by policy decisions.
In various comments, Warsh has expressed reservations about this approach and would appear to favour a less communicative Fed [1]. He is not a fan of forward guidance or the dot plot, partly because they may reduce policymakers’ willingness to adapt quickly to changing economic conditions.
It is possible that Warsh will therefore advocate changes to the Fed’s communication policy, possibly modifying or even abolishing the dot plot and changing the frequency and format of the press conference. However, such action would probably require a consensus on the Federal Open Market Committee (FOMC, the body responsible for setting US monetary policy), and it is unclear whether this would be forthcoming.
If the Fed does communicate less with investors, markets could become more vulnerable to surprises in monetary policy decisions. Higher levels of uncertainty could, in turn, lead to greater volatility in interest rate expectations and bond yields, with potentially wider ramifications for financial markets more generally.
A smaller balance sheet?
Another concern Warsh has with the current Fed is the size of its balance sheet. The Fed’s balance sheet has expanded massively in recent decades, as it embarked on periods of Quantitative Easing (QE, or buying bonds to inject liquidity into the system), first during the financial crisis in 2008 and more recently during the COVID pandemic.
Assets on the Fed’s balance sheet peaked at just under US$9.0 trillion in April 2022, but have since declined to around US$6.7 trillion [2] following a period of Quantitative Tightening (QT, or withdrawing liquidity from the system), as the Fed allowed some bond holdings to mature without fully replacing them.
Warsh dislikes the use of QE as a policy tool - preferring interest rates because they influence a broader cross-section of the economy – and he would also like to see the Fed reduce the size of its balance sheet. Theoretically, the Fed selling its bond holdings could put downward pressure on bond prices and, because prices and yields move inversely, push bond yields higher.
This might create further volatility in bond markets, not least given that yields have already risen [3] this year as investors fret about rising debt levels and the inflationary repercussions of the war in Iran.
In turn, rising bond yields could push up mortgage rates, which in the US are largely linked to longer-term interest rates. Such an outcome would not please the Trump administration, which is keen to see borrowing costs fall, and could therefore face political opposition.
A further challenge will be reducing the size of the Fed’s balance sheet without draining too much liquidity from the banking system. If bank reserves - the deposits that commercial banks hold at the Fed - become too scarce, it could lead to stress in short-term funding markets and disrupt financial conditions.
In addition, a Fed that is less inclined to resort to QE during periods of market stress may unnerve investors that have become accustomed to the so-called “Fed Put” (the belief that the Fed will intervene to prevent significant declines, acting as a safety net). The central bank used QE as a primary tool to inject liquidity and stabilise markets during the GFC and the pandemic.
However, a less interventionist approach under Warsh might force investors to become more cautious of downside risks, potentially reducing appetite for risk-taking. These potential issues suggest that the Fed will be wary of a rapid reduction in the Fed’s bond holdings.
Moreover, Warsh might find it difficult to convince the FOMC of the merits of a smaller balance sheet. Only six months ago, the Fed initiated a policy of so-called "Reserve Management Purchases" (RMP) to ensure ample liquidity in the banking system, specifically by purchasing short-term Treasury bills.
This has resulted in a renewed expansion of the Fed’s balance sheet, i.e. the opposite of what Warsh would ideally like to see.
A different inflation focus?
A Warsh-led Fed might also shift its focus to different measures of inflation. During his recent confirmation hearing, Warsh argued that “the data being used to judge inflation is quite imperfect." [4]. Rather than relying solely on traditional inflation measures, he has suggested the Fed should place greater emphasis on “trimmed average” measures (i.e. those that exclude the biggest increases and the largest declines, or smallest gains, in prices).
Warsh believes these measures provide a better guide to the underlying, broad-based trend in prices across the economy, especially when some prices are being distorted by one-off shocks.
The Fed’s current official inflation target is 2%, based on a measure of consumer prices known as PCE (Personal Consumption Expenditure) inflation. In practice, policymakers have often focused on “core” PCE inflation - which excludes food and energy prices - as a better guide to underlying inflation trends.
Annual inflation on the core PCE measure has been above 2% since early 2021 and has nudged higher in recent months to stand at 3.2% in March [5]. Somewhat conveniently for a Fed Chair that has been keen to lower interest rates, inflation on the trimmed-mean measure (as calculated by the Federal Reserve Bank of Dallas) is considerably lower, standing at just 2.4% in March [6].
If the Fed were to focus on a trimmed-mean index, the potential implication is that a lower underlying inflation rate could provide the justification for a restrictive approach to price stability and therefore result in a looser monetary policy. Under such a scenario, the Fed might be more willing to look through ‘one-off’ price hikes (possibly resulting from tariff increases or oil price spikes) if trimmed-mean measures suggest broader inflation pressures are contained.
This approach could carry risks. Core PCE inflation picked up and moved above 3% in April 2021 [7], but the trimmed-mean PCE did not rise above this level until November of that year [8]. With the benefit of hindsight, the Fed is widely seen as hiking rates too slowly in response to the 2021-22 inflation shock, but policy action could have been delayed even further if policymakers had focused primarily on trimmed mean inflation.
In terms of the market reaction, a shift toward targeting trimmed mean inflation - which is currently running below core PCE inflation - could lead investors to revise down expectations for future interest rates, potentially pushing short-term bond yields lower. However, longer-term bond yields could rise if investors demand a larger inflation risk premium amid concerns that policymakers may be underestimating underlying price pressures and could therefore respond too slowly to an emerging inflation shock.
This could result in a so-called steepening of the yield curve. More generally, rising long-term yields and increased volatility in government bond markets could create headwinds for both equity and credit markets.
Evolution rather than revolution
Kevin Warsh clearly has some big ideas about how the Fed could be reformed. Under Warsh, a Fed that communicates less with markets, shrinks the balance sheet and shifts its focus to trimmed-mean measures of inflation could result in higher levels of bond market volatility.
However, while a Warsh-led Fed might adopt a different tone, and some changes, such as to the frequency of press conferences and speeches, could occur relatively quickly, more significant reforms may face internal opposition and take much longer to implement, if they happen at all.
In advance of changes to balance sheet policy and details around the inflation target, extensive research would need to be carried out, and Warsh would have to build a consensus on the FOMC. Warsh himself has said he does not want to disrupt financial markets, so any change is likely to be incremental rather than radical.
In terms of the Fed’s policy stance, a near-term cut in interest rates looks unlikely even after Warsh takes up the helm on 22 May. When it comes to policy decisions, the Fed Chair is just one voter - albeit an influential one - among the 12 voting members of the FOMC.
Moreover, although interest rates were left unchanged at the last meeting in April, policymakers have adopted a more hawkish tone, with three members dissenting against the ‘easing bias’ in the Fed’s policy statement amid concerns over persistently above-target inflation. With inflation data released since the April Fed meeting surprising to the upside, and pipeline cost pressures rising due to the war in the Middle East and other factors [9], Warsh will face an uphill struggle convincing colleagues that interest rate cuts are warranted. Futures markets currently assign less than a 1% probability to a Fed rate cut before year-end, with around a 51% chance that rates remain unchanged in the current 3.5%–3.75% range, and a roughly 48% probability of one or more rate hikes [10].
As regards the Fed’s most closely watched policy tool - its benchmark interest rate – a new Fed Chair may result in little or no variation over the coming months despite the rhetoric of ‘regime change’.
26 May 2026
[1] https://www.reuters.com/business/fed-chair-nominee-warsh-has-big-ideas-here-are-some-his-own-words-2026-04-20/
[2] https://fred.stlouisfed.org/series/WALCL
[3] https://tradingeconomics.com/united-states/government-bond-yield
[4] https://finance.yahoo.com/economy/policy/articles/inflation-anyway-prospective-fed-chief-040100301.html
[5] https://fred.stlouisfed.org/series/PCEPILFE
[6] https://www.dallasfed.org/research/pce
[7] https://fred.stlouisfed.org/series/PCEPILFE
[8] https://fred.stlouisfed.org/series/PCETRIM12M159SFRBDAL
[9] https://www.cnbc.com/2026/05/12/cpi-inflation-april-2026-.html
[10] https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html