Fed's Warsh Is Managing Debt Costs, Not Inflation, Economist Says

U.S. federal debt-interest costs topped $1 trillion in fiscal year 2026, exceeding defense spending — and Brookings Institution senior fellow Robin Brooks says that number, not inflation, explains every twist in Federal Reserve policy under Chair Kevin Warsh.

Brooks laid out the argument in a Substack post on Thursday. In his view, the hawk-versus-dove framing that has puzzled Wall Street misses the point entirely.

"We're not in hawkish or dovish land. What's happening is yield curve management, which itself is a function of how precarious the U.S. debt picture is," Brooks wrote.

Why the hawk-or-dove question fails

Warsh, President Donald Trump's hand-picked Fed chair, has sent mixed signals since taking office. Wall Street expected him to lean toward looser monetary policy. Then he declared that inflation was a "choice," suggesting a tougher stance.

Over the summer, he floated alternative inflation gauges and suggested the bond market would do some of the Fed's tightening work. In August, he delivered a hawkish speech at Jackson Hole. In September, he led the Fed to a unanimous rate hike. Last week, he held off on backing another hike despite heating inflation, offering no explanation and no hints — a net dovish result.

Brooks argues the hot inflation readings can't rationalize those statements. The real driver sits in the Treasury market.

"The bottom line is that inflation and other macro data are secondary," Brooks said. "The twists and turns in Fed policy are about what's going on with long-term yields."

How big is the debt problem?

The numbers explain the urgency:

• Gross U.S. debt now exceeds $40 trillion; publicly held debt stands at 100% of GDP.
• Debt-interest costs topped $1 trillion in fiscal 2026, which ended in September — more than defense spending.
• The 10-year Treasury yield jumped more than 100 basis points above the Congressional Budget Office's 4.3% baseline earlier this year, though it has since dipped back below 5%.

Brooks suspects a de facto accord between the Fed and the Treasury Department to keep borrowing costs stable. He pointed to Treasury Secretary Scott Bessent's surprise announcement to buy back more long-term bonds, which briefly lowered yields. Bessent also intervened in the currency market to prop up the yen without Japan having to sell its U.S. debt holdings — sales that would have lifted yields.

Those attempts at yield management have had mixed success. Expectations that the Iran war will re-escalate pushed oil prices and yields higher. Signs the U.S. economy is running hot raised inflation and rate forecasts. Offsetting that: fears the AI boom will go bust took pressure off yields, and France's political turmoil and fiscal dysfunction sparked worries of a eurozone debt crisis — driving investors back to Treasuries as a safe haven.

"Warsh is neither hawk nor dove," Brooks declared. "Instead—like Bessent—he's just trying to keep long-term yields manageable."

When could interest costs outrun growth?

The strategy carries a risk economists call fiscal dominance: high debt and deficits override the Fed's ability to run independent monetary policy and fight inflation.

The escape hatch is growth. As long as nominal GDP growth stays above interest rates, the U.S. avoids a debt spiral where borrowing costs pile up faster than the economy expands. Nominal growth ran at 5.6% in the third quarter, helped by the AI boom and high inflation.

But the CBO was asked to assess scenarios where yields run 150 basis points and 50 basis points above its 4.3% baseline. Under the 150-point scenario, net interest costs rise by $4.9 trillion over the next decade, and publicly held debt reaches 133% of GDP by 2036.

Bank of America analysts took those CBO numbers and estimated that in the alternate scenario, the effective interest rate on government debt would exceed long-term nominal GDP growth — assumed at a 4% pace — as early as fiscal year 2028, which begins October 2027.

"However, both forces are likely to prove more temporary than permanent unless AI adoption ultimately delivers substantial productivity gains," BofA said in an Oct. 19 note. "Should that occur, concerns around fiscal sustainability would ease materially. Even so, we believe it is optimistic to assume the United States can simply grow its way out of its mounting debt burden."

The takeaway: if BofA's math holds, Warsh and Bessent have roughly a year before the debt math stops cooperating.