Will rising bond yields pressure Warsh to increase rates?

Next week the Federal Reserve Committee (Fed) will meet in the US to determine the trajectory of US interest rates. It is one of the key drivers we look at on a global basis to determine what will happen to investment and asset markets.

Kevin Warsh was recently sworn in to succeed Jerome Powell as chair of the Board of Governors of the Federal Reserve System. Warsh, who is 56 years old, is at the start of his 14-year term as governor, which expires in 2040. His appointment could reshape the institution in a number of ways.

Firstly, we have seen a lot of political pressure from the Trump administration for Warsh to reduce interest rates, and that is something we will be watching closely. A US Fed that is seen to have lost it’s independence will be a very negative sign for investors.

Secondly, he is also quite close to US Treasury Secretary Scott Bessent, and this could reinforce coordination between the Fed and the US Treasury. Just recently we have seen Bessent double the size of government bond buyback in a move that investors widely viewed as an attempt to halt the recent rapid rise in the US longer dated yields.

Inflation in the US is currently 3.4%, which is above the Fed’s long-term mandate to keep inflation below 2%. We believe this is being driven more by supply shocks from the Iran invasion rather than strong demand in the US economy, although the job market and broader economy have also been stronger being dragged along by the AI build out.

The prevailing narrative is focused on the large amount of borrowing by governments to fund their expenditure and keep growth going. This is the easier political choice rather than having honest conversations with voters to pay more tax. The market believes that bond market investors are starting to worry about the amount of debt and are therefore demanding a higher premium for borrowing to governments. This has led to market expectations on interest rates expressed through the forward rate curve shifting from a 30% chance of a rate increase to 60% currently.

Notably it’s not just US rates that are increasing but global bond markets that have risen to levels not seen in two decades. In addition to the prevailing market narrative, we believe that this is also part of a normalisation process from the unsustainably low yields we have seen over the last few years.

Although it seems pressure is mounting on Warsh to increase rates, our expectation is for the Fed to leave rates unchanged at this stage, and that really needs to be viewed in the context of global geopolitical competition rather than cooperation. Bringing inflation back to 2% is far from the US administration’s top priority at this stage and the US has been running at levels above this for a few years now.

The broader objective is to support the rebalancing of the US economy away from the large deficits they are running and towards greater US strategic autonomy. The US is currently running very high debt-to-GDP ratios and deficits at the moment, but historically, keeping real interest rates low has been one of the most powerful and common mechanisms for reducing a country’s debt-to-GDP ratio over time. It simply erodes the real value of debt faster than the economy grows.

We therefore believe that, over the longer term, the Fed may be pursuing that objective alongside, rather than instead of, price stability.