Investors Ramp Up Yield Curve Steepening Bets Under Warsh-Led Fed Policy Expectations

The market dynamics surrounding the Federal Reserve leadership transition represent a significant fixed-income positioning shift that began accelerating in early February 2026. Investors are fundamentally repricing U.S. Treasury markets based on expectations that Kevin Warsh, upon assuming the Fed chairmanship, will pursue an unconventional policy combination: interest rate reductions alongside continued shrinkage of the central bank’s approximately $6.59 trillion balance sheet [1]. This dual-action policy framework creates a unique market environment where opposing forces—rate cuts that typically flatten the yield curve and balance sheet runoff that tends to steepen it—could generate elevated volatility and term premia.

The 2-year/10-year Treasury spread expansion to 72.70 basis points on February 3, 2026 signals that market participants are positioning for sustained long-end yield pressure [1]. The 10-year Treasury yield trading around 4.22-4.27% reflects this steepening dynamics, while the 2-year yield at approximately 3.578% incorporates expectations for approximately 50 basis points of rate cuts throughout 2026, with the first reduction priced for the June 16-17 Federal Open Market Committee meeting [1][3]. This spread configuration represents a meaningful repricing from previous levels, indicating substantial capital flows into steepener strategies.

The equity market reaction on February 3, 2026—with the S&P 500 declining 1.37% to close at 6,889.93, the NASDAQ falling 2.22% to 23,141.08, and the Dow Jones dropping 0.72% to 49,001.01—coincides temporally with the steepening narrative [0]. This concurrent movement suggests a potential rotation from equity positions into longer-duration Treasury holdings as investors position for the anticipated policy framework. The Russell 2000’s 1.06% decline further indicates broad-based market caution, with small-cap stocks showing sensitivity to the shifting interest rate landscape.

The MOVE index, which measures bond market volatility, has declined to 59.30 from 84.32 in mid-November 2025 [1]. This reduction in rate volatility metrics suggests the market has not fully incorporated the potential implications of Warsh’s unconventional policy combination, creating a potential mispricing that could reverse sharply if policy implementation proves more challenging than currently anticipated.

: Market analysts have identified a fundamental tension in the anticipated Warsh policy framework. Jim Barnes, Chief Investment Officer at Bryn Mawr Trust, has characterized the combination of shrinking the balance sheet while simultaneously cutting rates as “a tough policy to administer” [1]. This assessment reflects the theoretical and practical challenges of pursuing opposing monetary policy tools simultaneously—quantitative tightening typically pushes long-end yields higher by reducing Fed demand for longer-dated securities, while rate cuts generally compress yields across the curve.

: The AI-driven productivity narrative that Warsh has previously cited as a disinflationary force introduces additional complexity into yield expectations [1]. If artificial intelligence and automation genuinely elevate structural productivity growth, this could push the neutral Federal funds rate—the equilibrium rate that neither stimulates nor restrains the economy—higher than current market pricing suggests. Such a development would imply sustained upward pressure on longer-term yields beyond current expectations.

: Oscar Munoz, Senior Rates Strategist at TD Securities, has highlighted potential uncertainty regarding the Federal Reserve Board’s composition and receptiveness to unconventional policy combinations [1]. This governance dimension adds another layer of complexity to the policy outlook, as Warsh’s ability to implement his preferred framework may depend on building consensus among fellow policymakers who may hold different views on the appropriate policy mix.

: The speed at which the 2s10s spread has widened to its steepest level since April 9 indicates rapid and substantial portfolio repositioning [1]. This positioning suggests investors believe the Warsh Fed policy framework is more likely than not to materialize, and they are proactively adjusting duration exposure ahead of formal policy implementation.

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The primary risk to current market positioning lies in the potential for policy implementation difficulties. Combining balance sheet shrinkage with interest rate cuts represents an unconventional approach that lacks extensive historical precedent, making the ultimate market impact difficult to predict with confidence. The potential for elevated term premia—investor compensation demanded for holding longer-duration bonds under uncertain policy conditions—could push 10-year yields higher than current expectations, creating mark-to-market losses for investors who have already positioned for steepening.

The inflation expectations dimension presents another risk vector. The yield curve steepening reflects, in part, market concerns about long-term inflation dynamics and fiscal deficit pressures rather than purely monetary policy mechanics. If inflation proves more persistent than anticipated, the Federal Reserve’s ability to implement rate cuts while simultaneously reducing its balance sheet could be constrained, forcing a reassessment of current market positioning.

The MOVE index decline to 59.30 suggests potential underpricing of volatility risk [1]. Should the Warsh Fed’s policy implementation prove more market-disruptive than currently anticipated, or should economic data force adjustments to the anticipated policy path, rate volatility could spike sharply, affecting portfolios positioned for continued gradual steepening.

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For fixed-income investors, the steepening environment creates tactical positioning opportunities. The current spread levels offer compensation for bearing duration risk that may prove attractive if the steepening trajectory continues as anticipated. Active yield curve management strategies—steepeners, barbell positions, and duration-adjusted exposures—may generate alpha for investors with appropriate risk tolerance and positioning flexibility.

The rotation dynamics between equities and fixed-income could continue presenting opportunities for investors positioned to capitalize on sector and asset class reallocation. Duration-sensitive equity sectors—including utilities, real estate investment trusts, and other rate-sensitive industries—may face continued pressure, while high-quality fixed-income assets could benefit from flight-to-quality dynamics if equity volatility increases.

Market data from February 3, 2026 provides a snapshot of current conditions and recent trajectory. The 2-year/10-year Treasury spread at 72.70 basis points represents the steepest level since April 9, reflecting active investor positioning for the anticipated Warsh Fed policy framework [1]. The 10-year Treasury yield in the 4.22-4.27% range and the 2-year yield at approximately 3.578% provide the current yield curve configuration [2][3].

Federal funds rate expectations have crystallized around approximately 50 basis points of cuts throughout 2026, with the first reduction priced for the June 16-17 FOMC meeting [1]. This expectation incorporates market assessments of economic conditions and the anticipated policy direction under incoming leadership.

The Federal Reserve’s balance sheet, standing at approximately $6.59 trillion, represents the quantitative dimension of policy that will interact with interest rate decisions under the anticipated Warsh framework [1]. The interaction between these policy tools creates market dynamics that warrant continued monitoring.

Fixed-income investors should review duration exposure in the context of these developing expectations, assess yield curve positioning strategies, and monitor Federal Reserve communications for signals regarding the likely policy implementation timeline and approach. The combination of rate cuts and balance sheet reduction creates a complex environment where both technical and fundamental factors will influence market outcomes.