Editor's Note: On August 28 (this Friday), according to the Federal Reserve's schedule, Chair Kevin Warsh will deliver his first Jackson Hole speech since taking office. Investors are not only focused on whether he will hint at the next interest rate direction but also on whether he will continue to reduce forward guidance and let the market independently form interest rate expectations.
Michael J. Kramer presents a more controversial interpretation in this article: Warsh may not intend to actively suppress long-term rates as the Fed has done in the past but instead may want to steepen the yield curve, allowing for higher term premiums and tighter bond market volatility to tighten financial conditions. Under this framework, the Fed may suppress demand pressures even without raising the policy rate, affecting mortgage rates, corporate borrowing costs, and stock valuations.
This is still the author's speculation about Warsh's policy intentions and not a confirmed Fed policy arrangement. What is truly noteworthy is that if the Fed reduces its management of market expectations, long-term rates may no longer passively reflect the rate hike path but become an independent variable influencing financial conditions. Friday's speech will provide the first significant validation of this assessment.
Below is the translation of the original article:
Earlier this week, market attention was mainly on Nvidia's earnings report; after Wednesday, the focus will shift to the Jackson Hole Global Central Bank Annual Symposium.
Federal Reserve Chair Kevin Warsh is scheduled to deliver a keynote speech on August 28. This will be his first appearance at Jackson Hole since taking office and will be a crucial window for the market to observe his monetary policy framework. The Fed and the Kansas City Fed's schedule shows that the speech will begin at 10 a.m. US Eastern Time.
Investors will be closely assessing whether Warsh has changed his stance on reducing forward guidance. Forward guidance is a monetary policy tool through public communication by central banks to influence market expectations of future interest rate paths. According to this article's author, Michael J. Kramer, Warsh is unlikely to change course: the Fed will reduce its "hand-holding guidance" to the market, allowing economic data and market prices to play a more critical role in pricing.
The resulting impact may not be limited to policy communication. Kramer assesses that Powell may allow long-end yields and bond volatility to rise, tightening financial conditions and thus reducing the immediate need for a rate hike.
Term Premium Mean Reversion: Could the 10-Year U.S. Treasury Yield Return to 5%?
The author notes that the U.S. Treasury term premium has started to increase. The term premium is the additional return investors require for holding long-term bonds instead of continually rolling over short-term bonds, mainly to compensate for future interest rates, inflation, and policy uncertainty.
This article relies on the ACM term premium model released by the New York Fed. ACM refers to the estimation framework established by Tobias Adrian, Richard Crump, and Emanuel Moench, used to decompose the long-term government bond yield into expected short-term rates and the term premium. It is worth mentioning that the term premium cannot be directly observed, and different models may yield different results.
Based on the data cited by the author, the 10-year U.S. Treasury's ACM term premium is approximately 82 basis points, still below the historical average of around 150 basis points from before the QE era. If the term premium were to return to this historical average, combined with the author's assumption of a slightly above 4% neutral rate, the 10-year U.S. Treasury yield could rise to above 5%.
This calculation is more of a scenario analysis rather than a definitive prediction of the 10-year yield. It relies on two key assumptions: that the term premium continues to rise and that the long-term neutral rate remains at a higher level. Any change in either condition could lead to significantly different outcomes.
However, what the author is truly concerned about is not the specific 5% level but the pricing logic of long-term rates: if the Fed no longer actively reduces policy uncertainty, investors may demand a higher term premium.
Raising Bond Volatility Without Hiking Rates
Reducing forward guidance may also increase the implied volatility in the bond market.
Despite recent rises in long-term yields, the MOVE index, which measures the implied volatility of U.S. Treasury options, remains relatively low. The author explains this as the market still believing it can roughly predict the Fed's upcoming policy path.
If this certainty dissipates, each Fed meeting could once again become an "event risk": investors would be unable to preclude the possibility of rate hikes, cuts, or continued pauses, and bond prices would become more sensitive to economic data and policy announcements. Without actual rate adjustments, a structural repricing in Treasury volatility could occur.
The author posits that this shift itself can tighten financial conditions. Higher 10-year yields could transmit to mortgage and corporate long-term borrowing costs, depress the valuations of long-duration assets such as equities; and higher rate volatility could also widen credit spreads, raising the cost of corporate debt issuance.
It is necessary to downgrade the understanding that the federal funds rate remains the core tool of the Fed's monetary policy and cannot simply be deemed "unimportant" in terms of short-term rates. What the author proposes is an additional layer of market interpretation: beyond the policy rate, long-term yields and bond volatility can equally impact the real economy, with their transmission possibly more direct.
Let the Long-End Tighten to Create Space for Short-End Easing
In Kramer's envisioned policy framework, the Fed may allow the yield curve to continue steepening, letting the long-end yield undertake the tightening role it has not fully played in the past.
Specifically, the Fed could reduce forward guidance, no longer striving to eliminate uncertainty at every policy meeting. In an environment where supply, inflation, and fiscal risks persist, investors would demand higher term premia, driving up long-term yields and bond volatility, allowing the market to accomplish some tightening.
If this process could dampen demand and sustain a continuous inflation rollback, the Fed may subsequently cut short-term policy rates. At that point, the yield curve may exhibit long-term rates remaining relatively elevated, with short-term rates gradually declining.
In other words, the path envisioned by the author is not the traditional "hike first, cut later" approach, but rather allowing the long-end to first tighten financial conditions, creating space for subsequent short-end easing.
However, this framework carries evident risks. The rise in long-term yields is not entirely under the Fed's control. If term premia surge excessively, mortgages, corporate financing, and fiscal interest burdens could all come under pressure; if the market interprets reduced communication as an unclear policy framework, rising volatility could damage the Fed's credibility rather than aiding in an orderly tightening.
Therefore, it is currently uncertain whether the rise in long-term yields is a policy channel that the Fed wishes to utilize or an additional compensation demanded by the market for inflation, fiscal, and policy uncertainty.
Japan Normalizes Rates, Adding Pressure to Global Long Bonds
Aside from changes in U.S. policy itself, the author also sees Japan as another driving force behind global rate hikes.
Under the latest Bank of Japan policy, Japan's unsecured overnight call rate target is currently around 1%. At the same time, Japan's 10-year breakeven inflation rate has approached 2%. The breakeven inflation rate is the difference between the nominal government bond yield and the inflation-linked bond yield of the same maturity, often seen as the market's estimate of future inflation, but it also includes liquidity and risk premiums.
The author believes that the resurgence of inflation expectations in Japan means that the market is preparing for further normalization of the Bank of Japan's monetary policy. According to the referenced TONAR futures pricing, the implied rates are approximately 1.19% for September, 1.41% for December, and 1.6% for the following year March. These figures reflect market pricing at the time of the article's publication and will continue to change with economic data and policy expectations, not representing a predetermined rate hike path by the Bank of Japan.
If Japan's rates continue to rise, global funds' demand for low-yield foreign bonds may weaken marginally, and global long-term rates will face more upward pressure. In this environment, even if Powell has not sent a clear rate hike signal, U.S. long-term bonds may not easily retreat.
What really needs to be observed on Friday is how Powell describes the rise in long-term yields: will he see it as having partially tightened for the Fed or believe that higher term premiums are bringing uncontrollable financial risks? Will he continue to reduce forward guidance, and will he explain how the Fed wants the market to interpret its policy reaction function?
Only when these questions are answered more clearly can we judge whether "letting long-end rates hike for the Fed" is a framework Powell may adopt or a story the market fills in based on his silence.
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