Key Points
- The Trump‑led Iran conflict drove U.S. inflation to a three‑year peak in May, creating conditions that could prompt the Federal Open Market Committee (FOMC) to act.
- Fed Chair Kevin Warsh seeks to substantially reduce the Federal Reserve’s $6.74 trillion balance sheet; however, such a move carries potential side effects.
- Warsh’s decision to withhold forward‑looking guidance may also influence bond market dynamics.
Recent weeks have featured several noteworthy developments on Wall Street. The Dow Jones Industrial Average ((DJINDICES: ^DJI)), the S&P 500 ((SNPINDEX: ^GSPC)) and the Nasdaq Composite ((NASDAQINDEX: ^IXIC)) have each reached record highs, while the largest initial public offering to date unfolded, and a rare shift in leadership occurred at the Federal Reserve.
May 15 marked the conclusion of Jerome Powell’s second term as Fed chair, and May 22 signified the inauguration of his successor, Kevin Warsh. Since the Fed’s establishment over 122 years ago, only 17 individuals have served as chair, including Warsh.
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Fed Chair Kevin Warsh intends to lead a reform‑oriented central bank. Image source: Official Federal Reserve Photo.
Warsh’s emergence comes at a particularly delicate juncture for the U.S. economy and financial markets. Inflation is climbing, and market participants are debating whether the FOMC will raise rates. The FOMC, a twelve‑member panel, dictates the nation’s monetary policy.
Nevertheless, it may be unexpected that Warsh and the FOMC can influence borrowing costs without directly changing the federal funds rate.
President Trump’s Iran war creates the backdrop for FOMC action
In February, the trailing‑twelve‑month inflation rate stood at 2.4%. After Powell and the FOMC executed six rate cuts between September 2024 and December 2025 and maintained an easing bias, additional cuts appeared likely. The subsequent Iran‑related conflict altered the landscape dramatically.
Shortly after hostilities began on February 28, Iran closed the Strait of Hormuz, causing the most significant disruption to global oil supplies in modern history. Approximately 20 % of the world’s crude oil production was halted, pushing energy prices sharply higher.
Consequently, the trailing‑twelve‑month inflation rate climbed to 4.2 % in May—the highest level recorded in three years—prompting the FOMC to pivot toward price‑stability objectives.
BREAKING: May CPI inflation rises to 4.2%, the highest level since April 2023.
Core CPI inflation also rises to 2.9%, the highest since September 2025.
Inflation in the US is officially back above 4% and more than double the Fed’s target.
Odds of Fed rate hikes are rising.
— The Kobeissi Letter (@KobeessiLetter) June 10, 2026
During Warsh’s first FOMC meeting as Fed chair in mid‑June, the easing‑bias language was omitted. Although the Federal Reserve did not formally signal an end to its rate‑cutting cycle, the lack of that language makes rate hikes as plausible as cuts.
Moreover, the most recent Summary of Economic Projections—commonly known as the dot plot—indicates that several FOMC participants expect interest rates to increase before the close of 2026. Of the 18 members who provided forecasts (not all of whom vote), nine projected a higher federal funds target rate by year‑end. Warsh chose not to offer any forward guidance.
While adjusting the federal funds target rate would be the most straightforward method for raising borrowing costs and tempering price increases, the committee possesses alternative, less obvious tools.
Kevin Warsh has articulated a reform agenda centered on scaling back the Federal Reserve’s balance sheet.
Kevin Warsh Nomination: one reason why market players are interpreting it as a hawkish pick is his emphasis on a radical balance-sheet reduction.
The $31 trillion U.S. economy requires liquidity and financing that exceed current capabilities…
— Joseph Brusuelas (@joebrusuelas) January 30, 2026
Such a reduction would involve selling a substantial portion of the Fed’s holdings of long‑term Treasury securities and mortgage‑backed assets.
Market participants recognize that bond prices and yields move inversely. If the Fed divests trillions of dollars in long‑term Treasuries, Treasury prices would fall and yields would rise, thereby increasing borrowing costs.
By shrinking its asset holdings and transitioning to a more passive market role, the Fed could push yields upward without formally altering the federal funds rate.
This is not the sole covert avenue for raising rates.
Another reform implemented by Warsh involves curtailing the frequency and scope of forward guidance. Rather than providing extensive forward‑looking statements, the new chair prefers to present raw data and allow markets to react to emerging economic information.
BREAKING: Fed Chair Kevin Warsh announces that the Fed has “dropped” forward guidance.
“Forward guidance is not the business we should be in,” he says.
— The Kobeissi Letter (@KobeissiLetter) June 17, 2026
However, dismantling years of central‑bank transparency may increase volatility in the bond market. The possible elimination of the dot plot, coupled with markedly concise FOMC statements that lack forward guidance, could prompt traders to push Treasury yields higher and modestly lift lending rates, all without an official change to the federal funds target.
Even if Warsh and the FOMC do not officially raise the federal funds rate, they retain additional subtle tools to affect price stability.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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