Warsh's Jackson Hole Speech Preview: Letting Long-End Rates "Do the Fed's Hiking"?

Original Title: Kevin Warsh's Jackson Hole Speech Puts Bond Yields on Notice

Original Author: Michael J. Kramer

Original Translation: Peggy

Editor's Note: On August 28 (this Friday), according to the Federal Reserve's schedule, Chairman Kevin Warsh will deliver his first Jackson Hole speech since taking office. Investors will be watching not only whether he hints at the next direction for interest rates, but also whether he will continue the communication approach of reducing forward guidance and allowing markets to form their own expectations about rates.

Note: The Jackson Hole Global Central Bank Symposium is hosted annually by the Kansas City Fed. It is a key meeting where central bank officials from various countries discuss economic and monetary policy, and also a critical window for markets to gauge Fed policy signals.

In this article, Michael J. Kramer offers a more controversial interpretation: Warsh may have no intention of actively suppressing long-end yields as past Feds have done, but may instead want to allow the yield curve to steepen, letting a higher term premium and bond volatility tighten financial conditions. Under this framework, even without raising the policy rate, the Fed could dampen demand through pressure on mortgages, corporate financing costs, and equity valuations.

This remains the author's speculation about Warsh's policy intentions, not a policy arrangement already confirmed by the Fed. What is truly worth watching is that if the Fed reduces its management of market expectations, long-end yields may no longer merely passively reflect the path of rate hikes, but could become an independent variable affecting financial conditions. Friday's speech will provide the first important test of this judgment.

The following is the original translation:

During the first half of this week, market attention was focused primarily on Nvidia's earnings report; after Wednesday, the spotlight shifts to the Jackson Hole Global Central Bank Symposium.

Federal Reserve Chairman Kevin Warsh is scheduled to deliver a keynote address on August 28. This will be his first appearance at Jackson Hole since assuming the chairmanship, and an important window for markets to observe his monetary policy framework. The schedule released by the Fed and the Kansas City Fed indicates the speech will begin at 10:00 AM ET.

Investors will focus on determining whether Warsh has changed his stance on reducing forward guidance. Forward guidance is a policy tool through which central banks influence market expectations about the future path of interest rates via public communication. In the view of this article's author, Michael J. Kramer, Warsh is unlikely to change course: the Fed will reduce its "hand-holding" guidance to markets, allowing economic data and market prices to assume a more significant price-setting function.

The implications may extend beyond policy communication. Kramer believes Warsh may allow long-end yields and bond volatility to rise, thereby tightening financial conditions and reducing the need for an immediate rate hike.

Term Premium Returns: Could the 10-Year Treasury Revisit 5%?

The author observes that the term premium on Treasuries has already begun to rise. The term premium is the additional compensation investors demand for holding long-term bonds rather than continuously rolling over short-term bonds, primarily to compensate for uncertainty around future rates, inflation, and policy.

This article uses the ACM term premium model published by the New York Fed. ACM refers to the estimation framework developed by Tobias Adrian, Richard Crump, and Emanuel Moench, used to decompose long-term Treasury yields into expected short-term rates and a term premium. It should be noted that the term premium cannot be directly observed, and different models may produce different results.

According to the data cited by the author, the ACM term premium on the 10-year Treasury is approximately 82 basis points, still below the average of roughly 150 basis points seen in the decades before QE was implemented. If the term premium reverts to that historical average, combined with the author's assumption of a neutral rate slightly above 4%, the 10-year Treasury yield could rise above 5%.

The ACM term premium on the 10-year U.S. Treasury has recovered, but by the author's measure, it remains below the long-term average before QE.

This calculation is closer to a scenario analysis than a definitive forecast of the 10-year yield. It relies on two key assumptions: the term premium continues to rise, and the long-run neutral rate remains at an elevated level. A change in either condition could lead to significantly different outcomes.

But what the author is really concerned about is not the specific level of 5%, but the pricing logic of long-end rates: if the Fed no longer actively reduces policy uncertainty, investors may demand greater term compensation.

Raising Bond Volatility Without a Rate Hike

Reducing forward guidance could also push up implied volatility in the bond market.

Although long-end yields have already risen recently, the MOVE index, which measures implied volatility in Treasury options, remains at relatively low levels. The author interprets this as markets still believing they can broadly predict the Fed's next policy moves.

Long-end yields have already risen, but implied volatility in Treasury options has not yet been significantly repriced. The author believes reducing forward guidance could change this.

If that certainty disappears, every FOMC meeting could once again become an "open event": investors would be unable to rule out a hike, a cut, or another pause in advance, and bond prices would become more sensitive to economic data and policy statements. Without actually adjusting rates, Treasury volatility could undergo a structural repricing.

The author argues that such a change could itself tighten financial conditions. A higher 10-year yield would transmit to mortgage rates and long-term corporate financing costs, compressing valuations of long-duration assets like equities; higher rate volatility could also widen credit spreads and raise corporate issuance costs.

It is important to keep perspective: the federal funds rate remains the core tool of Fed monetary policy, and one should not simply conclude that short-term rates are "unimportant." The author offers another layer of market interpretation: beyond the policy rate, long-end yields and bond volatility can also affect the real economy, and their transmission may be more direct.

Let the Long End Tighten, Then Create Room for Short-End Cuts

In the policy framework Kramer envisions, the Fed may allow the yield curve to continue steepening, letting long-end rates assume a tightening function that was not fully utilized in the past.

Specifically, the Fed could reduce forward guidance and stop trying to eliminate uncertainty around every policy meeting. In an environment where supply, inflation, and fiscal risks persist, investors would demand a higher term premium, pushing up long-end yields and bond volatility, allowing the market to execute part of the tightening.

If this process can dampen demand and push inflation down sustainably, the Fed could then lower short-term policy rates. At that point, the yield curve might exhibit relatively elevated long-end rates alongside gradually declining short-end rates.

In other words, the path the author envisions is not the traditional "hike first, then cut," but rather letting the long end tighten financial conditions first, thereby creating room for short-end rate cuts.

However, this framework carries notable risks. The rise in long-end yields is not entirely within the Fed's control. If the term premium rises too much, mortgage rates, corporate financing costs, and fiscal interest burdens could all come under pressure simultaneously; if markets interpret reduced communication as a lack of policy framework clarity, higher volatility could damage the Fed's credibility rather than help it execute an orderly tightening.

Therefore, it is not yet possible to confirm whether rising long-end yields are a policy channel Warsh intends to use, or merely additional compensation markets demand for inflation, fiscal, and policy uncertainty.

Japan's Rate Normalization Adds More Pressure to Global Long Bonds

Beyond U.S. domestic policy changes, the author also views Japan as another factor pushing global rates higher.

Under the Bank of Japan's latest policy, the target for the unsecured overnight call rate is currently around 1%. Meanwhile, Japan's 10-year breakeven inflation rate has approached 2%. The breakeven inflation rate is the difference between yields on nominal government bonds and inflation-linked bonds of the same maturity, generally viewed as the market's estimate of future inflation, though it also contains liquidity and risk premiums.

Japan's 10-year breakeven inflation rate has risen to around 2%, fueling market expectations of further BOJ policy normalization.

The author believes the rebound in Japanese inflation expectations means markets are preparing for further BOJ policy normalization. Based on TONAR futures pricing cited by the author, market-implied rates are approximately 1.19% for September, 1.41% for December, and 1.6% for March of the following year. These figures reflect market pricing at the time of publication and will continue to evolve with economic data and policy expectations; they do not represent a confirmed BOJ rate hike path.

TONAR futures pricing at the time of publication shows markets pricing in the possibility of further rises in Japanese short-term rates. Futures prices shift with data and policy expectations and do not represent a confirmed BOJ rate path.

If Japanese rates continue to rise, global demand for low-yielding overseas bonds may weaken at the margin, adding further upward pressure on global long-term rates. In such an environment, even if Warsh signals no explicit rate hikes, U.S. long-end yields may not easily retreat.

The key thing to watch on Friday is how Warsh characterizes the rise in long-end yields: will he treat it as already doing part of the Fed's tightening work, or as an indication that a higher term premium is creating uncontrollable financial risks? Will he continue reducing forward guidance, and will he explain how the Fed wants markets to understand its reaction function?

Only when these questions are answered more clearly can we determine whether "letting the long end hike for the Fed" is a policy framework Warsh might actually adopt, or merely a story markets have constructed from his silence.

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