The tenure of Federal Reserve Chair Jerome Powell is concluding, with his successor, Kevin Warsh, poised to implement two significant changes at the central bank. Both changes have the potential to unsettle the U.S. stock market, which is currently at historic highs in both index levels and valuations, a critical factor for the broader U.S. economy. A pivotal date has arrived. May 15th marks Powell's final day as Fed Chair and is expected to be the first day of Kevin Warsh's initial term leading the institution. Warsh previously served on the Federal Reserve Board for five years (February 24, 2006, to March 31, 2011), a period encompassing the global financial crisis, providing him with crucial experience for this leadership role.
However, a Fed under Warsh's leadership is expected to bring changes that could threaten the record-breaking rallies of the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite indices, which have recently been driven by narratives around an AI computing boom. For financial markets, the combined effect of Warsh's proposed reforms—deleveraging the Fed's balance sheet and redefining its analytical framework for inflation—would be to increase discount rate pressure on highly valued assets.
With inflation still elevated, energy shocks unresolved, and a resilient labor market, the new Chair will find it difficult to pivot quickly to rate cuts. If he simultaneously advances balance sheet reduction, deemphasizes aggressive forward guidance, and reinforces the priority of price stability, the market will gradually shift from "Powell-era rate cut expectation trades" to "Warsh-era term premium and inflation credibility trades." For the U.S. Treasury market, this implies that yields on 10-year and longer-dated bonds will find it harder to decline rapidly, thereby limiting valuation expansion for global risk assets like equities. For the U.S. dollar, it could provide periodic support.
**Kevin Warsh Aims to De-leverage the Fed's Balance Sheet** Warsh's core reform areas include the balance sheet, inflation analysis, and changes to the central bank's internal technical and monetary policy culture, though these shifts are likely to be gradual. A long-standing criticism from Warsh has been the expanding size of the world's largest central bank's balance sheet. From August 2008 to March 2022, the total assets held by the Federal Reserve grew approximately tenfold, nearing $9 trillion. Although the previous (now concluded) quantitative tightening cycle helped reduce this figure to about $6.7 trillion as of May 6, 2026, Powell's successor clearly desires a more substantial reduction in balance sheet leverage.
The issue is not whether selling assets—primarily composed of U.S. Treasuries and mortgage-backed securities (MBS)—is right or wrong. The problem is that selling trillions of dollars in long-term U.S. Treasuries could unleash a series of unintended, negative consequences for Wall Street. Bond prices and yields have an inverse relationship. Selling trillions in Treasuries would depress bond prices and significantly push up yields, thereby raising long-term benchmark borrowing costs for consumers and businesses.
Even if Warsh and other members of the Federal Open Market Committee (FOMC)—the 12-person body responsible for setting U.S. monetary policy—do not intend to advance the rate hike expectations currently being priced by markets, de-leveraging the Fed's balance sheet would effectively produce a similar tightening outcome. A stock market at historically high valuations is counting on lower rates to fuel an unprecedented wave of AI data center construction and other costly, potentially transformative projects for U.S. economic growth. In other words, even without the FOMC directly raising rates, an acceleration in the Fed's sales or reduction of its long-term Treasury and MBS holdings would depress bond prices, push up long-end yields, and achieve implicit tightening through the "term premium" channel.
Term premium refers to the extra yield investors demand as compensation for the risk of holding long-term bonds. A 2025 IMF policy study has clearly found that the link between deficits, interest-bearing debt, higher long-term rates, and higher term premiums has strengthened significantly following a marked deterioration in fiscal conditions. Capital Group notes that quantitative easing and Operation Twist previously suppressed term premiums. Warsh's long-standing criticism of the Fed's balance sheet size suggests that long-end yields will be more driven by inflation expectations, fiscal dynamics, global demand for U.S. debt, and term premiums.
The 10-year U.S. Treasury yield, often called the "anchor for global asset pricing," if driven upward by fiscal stimulus-induced term premiums, would undoubtedly pressure valuations for high-yield corporate bonds, the AI-linked tech stocks driving the global equity bull run, and even cryptocurrencies—the world's hottest risk assets. If yields on 10-year and longer U.S. Treasuries continue to rise, it would equate to "significantly higher funding costs + weakening liquidity expectations + a larger macroeconomic denominator" occurring simultaneously for core risk assets like equities, cryptocurrencies, and high-yield corporate bonds.
**Powell's Successor Wants to Change How You Understand Inflation** Beyond reducing the central bank's $6.7 trillion balance sheet, Powell's successor has explicitly stated in testimony before the Senate Banking Committee that he wishes to change the economic definition of "inflation" for the Fed and potentially global central banks. Since January 2012, the FOMC has maintained a firm monetary policy target of 2% long-term inflation. However, according to Warsh, "Price stability should be a dynamic state of price change such that no one is talking about it during that period." This idea, seemingly aiming to abandon a firm inflation target in favor of a noticeably more ambiguous definition of price change, should grant the Fed greater flexibility in adjusting its monetary policy stance or taking action.
While this may sound advantageous on paper, it carries significant risk of disrupting Wall Street's robust bull market. Some institutional investors even worry that Warsh's move is intended to better advance the "rate cut plan" favored by President Trump against a backdrop of still-high inflation. Since the start of the Iran conflict on February 28, energy prices have surged. The closure of the Strait of Hormuz caused the largest energy supply disruption in modern history and decisively pushed inflation higher over the past 12 months. Undoubtedly, U.S. consumers and businesses have recently been discussing inflationary pressures.
If Warsh succeeds in changing how the FOMC weighs inflation, the price pressures from the Iran conflict could quickly prompt more FOMC members to shift toward a neutral or even hawkish stance. Although the Dow, S&P 500, and Nasdaq have performed well despite rapidly rising inflation, a decisive pivot by a Warsh-led Fed could swiftly alter Wall Street's tone toward the stock market.
Warsh has suggested that price stability should be a state where "no one is talking about price changes." This implies he may not mechanically target a 2% point but focus more on whether inflation has entered public discourse, business pricing, wage negotiations, and financial market expectations. On the surface, this offers greater policy flexibility. However, Wall Street giants like JPMorgan have recently indicated that in the current context of the Iran conflict boosting energy prices and rekindling U.S. inflation, such a framework could also lead the currently hawkish-leaning FOMC to pivot more quickly toward a "hawkish-leaning stance." Compared to the many hawkish voices, as Fed Chair, Warsh holds only one vote.
The Fed Chair wields significant influence, setting the agenda, communication framework, and market expectations. However, within the FOMC voting mechanism, he is essentially just one voting member. If a majority of members believe inflationary pressures do not permit rate cuts, Warsh would find it difficult to unilaterally force a dovish path. Against a backdrop of oil price shocks and reaccelerating inflation, even if Warsh personally faces political pressure to cut rates, a hawkish consensus within the FOMC could force the Fed to maintain high rates for longer, even reopening the risk of hikes. As Chair, Warsh possesses strong agenda-setting and communication powers but cannot bypass the majority opinion of the Committee.
**Treasury Market Braces for 5% Era as Taper Debate Exposes Fed Rifts** For financial markets, the most important factor is not whether Warsh personally "wants to cut rates," but whether the bond market believes he can maintain the Fed's anti-inflation credibility. If Warsh releases dovish signals too early amid high inflation, the long-end of the Treasury market could "punish" the policy shift through unanchored inflation expectations and rising term premiums, pushing the 10-year yield toward or even testing 5%. Higher oil prices make inflation harder to subdue, leading investors to demand greater compensation. A rising 10-year yield increases the discount rate for mortgages, corporate bonds, leveraged loans, and equity valuations, directly pressuring highly valued U.S. stocks and the AI capital expenditure narrative.
A deeper policy preference of Warsh's is to normalize the Fed's balance sheet. He has long criticized the crisis-era large-scale asset purchases for creating an oversized Fed portfolio that could distort market prices. The current Fed asset size of approximately $6.7 trillion remains far above pre-financial crisis levels. The issue is that balance sheet reduction is not technically neutral: reducing the Fed's holdings of Treasuries and MBS removes a significant marginal buyer, increases the duration supply the market must absorb, depresses bond prices, pushes up long-term yields, and may steepen the yield curve.
Fed Governor Barr has publicly opposed shrinking the Fed's asset size by lowering bank liquidity rules, calling it "the wrong objective," and stated that many related proposals would weaken bank resilience, hinder money market functioning, and threaten financial stability. He emphasized that the lesson from the 2023 banking stress events was not to lower liquidity requirements but to raise them. This indicates Warsh will likely face two fronts upon taking office: an external market front, where investors demand he prove Fed independence between inflation and political pressures, and an internal institutional front, where Fed Governors, regional Fed Presidents, and regulatory-minded officials impose constraints on aggressive balance sheet reduction.
New York Fed President Williams and Governor Waller have previously expressed skepticism about returning to a "scarce reserves" framework. This shows the Fed is not uniformly supportive of shrinking the balance sheet by suppressing reserves and weakening liquidity requirements, meaning Warsh must first build consensus within the FOMC to advance balance sheet reforms. If consensus builds slowly, the policy path could involve a combination of "rates on hold, cautious balance sheet reduction, and markets continuously pricing the risk of rising long-end yields."
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