Federal Reserve Chair Kevin Warsh may favour tighter policy, but the Fed and the Treasury are pursuing conflicting objectives. While Warsh focuses on inflation, Treasury Secretary Scott Bessent is increasingly concerned about rising borrowing costs.
The third discussion in OMFIF’s Money Disrupted series explored how this tension clouds the direction of US policy and heightens existing concerns about the Fed’s independence. Faced with political pressure, Warsh is likely to prioritise price stability to preserve the Fed’s credibility. The resulting uncertainty has brought dollar dominance back into focus, although no obvious substitute is in sight.
Artificial intelligence offers a possible disinflationary counterweight. Its productivity gains could eventually expand supply and lower costs, but supply-side and fiscal concerns are likely to dominate in the near term. The benefits of AI may be widespread, but the profits may not be, leaving bond and equity valuations vulnerable to repricing.
The policy tug-of-war
Warsh sent a hawkish signal in his speech at the Jackson Hole Policy Symposium, calling the 2% inflation target firm and fixed. The latest payrolls release, confirming the labour market’s resilience, lent support to that stance. Although Warsh avoided explicit forward guidance, his remarks shifted attention to the inflation side of the Fed’s dual mandate and strengthened expectations of future rate increases. Rising oil prices are reinforcing the case for tighter policy.
The Treasury is pulling in another direction. Bessent has argued that yields do not reflect fundamentals, while his policies indicate growing concern about soaring borrowing costs. Expanded bond buybacks have blurred the line between liquidity support and market intervention. In July, the Treasury also sold euros rather than dollars to buy yen, supporting Japan’s intervention and reducing the volume of US Treasuries Japan needed to sell. Together, these measures are unsettling markets by resisting higher yields without addressing their underlying causes.
Political pressure on the Fed and rising defence spending compound the inconsistency. Attacks on Jerome Powell and the attempted removal of Lisa Cook have intensified concerns about Fed independence, while President Donald Trump continues to demand lower rates. These pressures echo 1951, when the Truman administration asked the Fed to suppress borrowing costs as the Korean war increased financing needs. The central bank resisted in order to contain inflation, and the resulting Treasury–Fed Accord reasserted its control over monetary policy. Similarly, Warsh is likely to prioritise the Fed’s credibility by putting price stability ahead of short-term political demands.
Dollar dominance by default
These policy tensions extend beyond the inflation outlook, adding uncertainty around the dollar and the continued appeal of Treasuries as safe assets. Intervention may steady disorderly markets, but ad hoc efforts to contain yields treat the symptoms rather than the underlying fiscal and inflationary pressures. By blurring the line between debt management and market support, the Treasury risks raising the term premium and weakening confidence in dollar assets.
This does not mean the dollar is about to lose its reserve status. Its share of global foreign exchange reserves rose to 57% in the first quarter of 2026 and has remained broadly stable. Yet gold demand and OMFIF’s Global Public Investor 2026 point to gradual diversification: 79% of surveyed central banks expect the global monetary system to become more multipolar.
There is also no obvious substitute. The euro is the closest contender, but political fragmentation makes it harder to create a large, liquid and homogeneous safe asset. Jean-Luc Mélenchon has proposed cancelling part of France’s debt held by the Banque de France and the European Central Bank, an idea ECB President Christine Lagarde called ‘financially dangerous’. Meanwhile, Alternative for Germany advocates leaving the euro and replacing the European Union with a looser association of sovereign states. Europe has the necessary economic scale but still lacks the fiscal architecture and political cohesion to support a stronger reserve currency. The dollar therefore remains dominant, supported partly by the absence of a viable alternative.
AI’s promise and credit risk
Beyond these policy tensions, AI adds another source of uncertainty for inflation, interest rates and financial markets.
AI may eventually make Warsh’s job easier. By enabling firms to produce more with the same resources, it could lower costs, expand supply and ease inflation. Yet these gains may take years to materialise, while the current investment boom is already increasing demand for electronics and electricity. Even if AI ultimately proves disinflationary, the Fed’s immediate focus will remain on bringing down sticky inflation. Conversely, a sharp repricing of AI-related assets could tighten financial conditions and complicate further rate rises.
It is also uncertain whether AI’s economic benefits will translate into durable earnings for the companies funding its development. The 19th-century railway boom offers a useful parallel. Railways transformed commerce and raised productivity, but overbuilding, competition and heavy borrowing undermined returns and pushed many operators into bankruptcy. Similarly, AI applications in medicine, pharmaceuticals and education could deliver substantial social benefits without generating commensurate profits for today’s hyperscalers.
The growing use of borrowing to fund AI capital expenditure adds to these concerns. The five largest hyperscalers issued $121bn of US corporate bonds in 2025, more than four times their 2020-24 annual average, while private credit is also financing AI infrastructure. If earnings disappoint, investors may reassess equity valuations and credit risk, potentially widening spreads and raising refinancing costs.
Warsh should defend the Fed’s credibility, but quelling inflation will also depend on fiscal policy, supply shocks and AI’s effects on productivity and financial conditions.
Christos Panourgias is an Economist at OMFIF.
Join OMFIF on 8 October for the next instalment of Money Disrupted: AI, capital markets and financial stability.
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