Market Commentary

• Potential for higher income: New longer-maturity bonds, certificates of deposit (CDs), and other fixed-income investments could offer higher yields if the yield curve steepens over time.
• More price volatility: Bond prices — especially for longer-maturity bonds — may be more volatile as markets adjust to a smaller Federal Reserve (Fed) footprint and less support from Fed bond holdings.
• Portfolio approach: Shorter- and intermediate-maturity bonds may hold up better in this environment while longer-maturity holdings could face pressure. Mortgage-related investments could also be more volatile if the Fed significantly reduces its mortgage-backed securities holdings.

Kevin Warsh is President Donald Trump’s pick to become the next chair of the Federal Reserve. With the Department of Justice having dropped its probe into Chair Powell, Warsh’s confirmation is now expected to move forward; the 56-yearold former Fed governor would replace Jerome Powell when Powell’s term ends in May 2026. Warsh served on the Fed’s Board of Governors from 2006 to 2011 during the financial crisis. He also has Wall Street experience and is known as a thoughtful, reform-minded economist. He has said he will act independently while pursuing changes at the Fed.

Warsh believes the Fed has become too large and too complex. He wants to narrow its focus to its core responsibilities: keeping prices stable (managing inflation) and supporting a healthy job market. He has suggested the Fed should rely less on its large balance sheet where the Fed buys and holds large amounts of bonds. Today, the Fed’s balance sheet is about $6.7 trillion — about seven to eight times larger than its pre-financial-crisis level in 2007 but down from a peak near $9 trillion in 2022. Instead, he would prefer to focus on more traditional tools, such as the federal funds rate. He may also support reviewing how the Fed measures inflation and taking a fresh look at possibly moving away from a strict 2% target.

Warsh has signaled he would like to cut interest rates, especially if artificial intelligence boosts productivity and helps keep inflation in check. However, he has emphasized that any decisions would be data-driven and not directed by the White House. Fed chairs also typically build consensus for any action within the Federal Open Market Committee (FOMC). In practice, he would need support from other voting members to approve major policy changes, which limits how much he could do on his own.

We expect any shift in Fed policy under a new chair to be gradual. If Warsh is able to implement his priorities, the Fed could slowly lower short-term interest rates while also shrinking its balance sheet. That combination could put upward pressure on longer-term interest rates over time.

For fixed-income investors, the outlook under a Warsh-led Fed is mixed. The main things to watch are possible rate cuts over time and a gradual reduction in the Fed’s bond holdings. We do not expect these changes to happen all at once.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Bonds are subject to market, interest rate, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.

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