Investors ramp up bets on steeper yield curve under Warsh-led Fed

• The Fed's balance sheet currently stands at $6.59 trillion; reducing it would withdraw government demand for Treasuries, pushing long-dated yields higher and steepening the curve
• Markets still price in roughly two quarter-point rate cuts in 2026, with the first expected at the June 16-17 meeting, despite concerns about Warsh's policy shift from his previous hawkish stance (2006-2011)
• The Treasury 2/10-year yield curve hit 72.70 basis points on February 2, its steepest level since April 9, driven by inflation concerns and fiscal deficit fears even before Warsh's expected May confirmation

Summary: Investors Ramp Up Bets on Steeper Yield Curve Under Warsh-Led Fed

Investors are increasingly positioning for a steeper Treasury yield curve as incoming Federal Reserve Chair Kevin Warsh is expected to shrink the central bank's balance sheet while cutting short-term rates. The Fed's balance sheet currently stands at approximately $6.59 trillion.

Key Market Dynamics:

Warsh's anticipated balance sheet reduction would reduce government demand for Treasuries, pushing long-dated yields higher and steepening the yield curve. The Treasury 2/10-year curve reached 72.70 basis points on Monday—its steepest level since April 9—before flattening slightly on Tuesday. Rate futures indicate traders expect two quarter-point rate cuts in 2026, with the first anticipated at the June 16-17 meeting.

Policy Tensions:

Analysts highlight conflicting policy directions: cutting short-term rates (dovish) while simultaneously shrinking the balance sheet (hawkish). This dual approach could keep long-term rates elevated, complicating efforts to ease financial conditions and potentially increasing term premia.

Volatility Concerns:

Despite Warsh's hawkish reputation during his 2006-2011 Fed tenure, he has recently adopted more dovish positions, aligning with President Trump's preference for rate cuts. He cites AI-driven productivity gains as disinflationary. However, market participants expect him to eventually revert to hawkish instincts, likely driving rate volatility higher. The MOVE index, measuring rate volatility, currently sits at 59.30, down from 84.32 in mid-November.

Timeline:

Warsh, currently at Stanford's Hoover Institution, must be confirmed by the Senate before replacing Jerome Powell, whose term ends mid-May 2026.

Implications:

Higher long-term yields would increase borrowing costs across mortgages, corporate bonds, and equity financing, tightening financial conditions economy-wide.