Warsh's Jackson Hole Speech: Let Long-End Rates Do the Fed's Tightening?

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

Original author: Michael J. Kramer

Original compilation: Peggy

Editor's note: On Aug. 28 (this Friday), according to the Federal Reserve's published schedule, Chair Kevin Warsh will deliver his first Jackson Hole speech since taking office. Investors are watching not only whether he hints at the next rate move, but also whether he continues the communication approach of reducing forward guidance and letting markets form their own rate expectations.

Note: The Jackson Hole Economic Symposium is hosted annually by the Federal Reserve Bank of Kansas City. It is a key meeting for central bank officials to discuss economic and monetary policy, and a critical window for markets to observe Fed policy signals.

Michael J. Kramer offers a more controversial interpretation in this article: Warsh may have no intention of actively pushing down long-end rates as past Fed chairs did. Instead, he may allow the yield curve to steepen, letting higher term premiums and bond volatility tighten financial conditions. Under this framework, the Fed could dampen demand through pressure on mortgage rates, corporate financing costs, and equity valuations—even without raising the policy rate.

This remains the author's speculation about Warsh's policy intentions, not a confirmed Fed policy arrangement. What truly matters is that if the Fed reduces its management of market expectations, long-end rates may no longer be a passive reflection of the rate path, but an independent variable affecting financial conditions. Friday's speech will provide the first important test of this view.

Below is the compiled translation of the original article:

In the first half of this week, market attention was mainly on Nvidia's earnings; after Wednesday, the focus will shift to the Jackson Hole Economic Symposium.

Fed Chair Kevin Warsh is scheduled to deliver the keynote speech on Aug. 28. This will be his first Jackson Hole appearance since taking office, and a key window for markets to observe his monetary policy framework. According to the schedule released by the Fed and the Kansas City Fed, the speech will begin at 10 a.m. Eastern Time.

Investors will focus on 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 rate path via public communication. In the view of the author, Michael J. Kramer, Warsh is unlikely to change direction: the Fed will reduce its "hand-holding" of markets, letting economic data and market prices play a more important pricing role.

The impact may extend beyond policy communication. Kramer argues that Warsh may allow long-end yields and bond volatility to rise, thereby tightening financial conditions and reducing the need for immediate rate hikes.

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

The author observes that the term premium on U.S. Treasuries has begun to rise. The term premium is the extra return investors demand for holding long-term bonds instead of continuously rolling over short-term bonds, mainly compensating for future interest rate, inflation, and policy uncertainty.

This article uses the ACM term premium model published by the New York Fed. ACM refers to the estimation framework established by Tobias Adrian, Richard Crump, and Emanuel Moench, which decomposes long-term Treasury yields into expected short-term rates and the 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 about 82 basis points, still below the pre-QE average of about 150 basis points over several decades. If the term premium returns to this historical average, combined with the author's assumed 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 rebounded, but by the author's measure, it remains below the long-term average before QE.

This calculation is closer to a scenario exercise than a definitive forecast for 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 elevated. If either condition changes, the outcome could be significantly different.

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

No Rate Hike Needed to Boost Bond Volatility

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

Although long-end yields have risen recently, the MOVE index, which measures implied volatility of U.S. Treasury options, remains relatively low. The author interprets this as the market still believing it can roughly predict the Fed's next policy path.

Long-end yields have risen, but implied volatility on Treasury options has not yet repriced significantly. The author argues that reducing forward guidance could change this.

If that certainty disappears, every FOMC meeting could become an "open event" again: investors cannot rule out hikes, cuts, or continued pauses in advance, and bond prices will become more sensitive to economic data and policy statements. Without actually adjusting interest rates, Treasury volatility could undergo a structural repricing.

The author believes this change alone can tighten financial conditions. Higher 10-year yields transmit to mortgage rates and corporate long-term financing costs, compressing valuations of long-duration assets such as equities; higher interest rate volatility could also widen credit spreads and raise corporate borrowing costs.

It should be understood that the federal funds rate remains the core tool of Fed monetary policy, and it cannot be simply assumed that short-end 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 Do the Tightening, Then Create Room for Short-End Cuts

In the policy framework envisioned by Kramer, the Fed may allow the yield curve to continue steepening, letting long-end rates play the tightening role they failed to fully exert in the past.

Specifically, the Fed could reduce forward guidance and stop trying to eliminate uncertainty at every policy meeting. In an environment where supply, inflation, and fiscal risks persist, investors will demand higher term premiums, pushing long-end yields and bond volatility higher, with the market doing part of the tightening.

If this process dampens demand and drives inflation sustainably lower, the Fed could subsequently cut the short-term policy rate. At that point, the yield curve may show long-end rates staying relatively high while short-end rates gradually decline.

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

However, this framework carries clear risks. The rise in long-end yields is not fully under the Fed's control. If the term premium rises too much, mortgage, corporate financing, and fiscal interest burdens could all come under pressure simultaneously; if the market interprets reduced communication as an unclear policy framework, rising volatility could damage the Fed's credibility rather than help it achieve an orderly tightening.

Therefore, it is still unclear whether the rise in long-end rates is a policy channel Warsh intends to use, or simply additional compensation demanded by the market for inflation, fiscal, and policy uncertainty.

Japan's Rate Normalization Adds Pressure on Global Long-End Bonds

Beyond U.S. policy changes, the author also sees Japan as another driver of global rate increases.

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

Japan's 10-year breakeven inflation rate has risen to about 2%, and market expectations for further BOJ policy normalization have heated up accordingly.

The author argues that the rebound in Japan's inflation expectations means the market is preparing for further BOJ policy normalization. According to the TONAR futures pricing he cites, the market-implied rates are about 1.19% in September, 1.41% in December, and 1.6% in March of the following year. These figures reflect market pricing at the time of publication and will continue to change with economic data and policy expectations; they do not represent a confirmed BOJ rate path.

TONAR futures pricing at the time of publication shows the market is pricing in the possibility of further increases in Japan's short-term rates. Futures prices change 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 more upward pressure on global long-term rates. In this environment, even if Warsh sends no clear hiking signal, the long end of the Treasury market may not easily fall back.

What really needs to be watched on Friday is how Warsh describes the rise in long-end yields: will he view it as having already done part of the Fed's tightening, or as an uncontrollable financial risk from higher term premiums? Will he continue to reduce forward guidance, and will he explain how the Fed wants the market to understand its policy reaction function?

Only when these questions are answered more clearly can we judge whether "letting the long end hike for the Fed" is a policy framework Warsh may adopt, or a story the market has filled in on its own from his silence.

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