The Federal Reserve enters Jackson Hole with inflation above target, elevated long-term Treasury yields, and an active review of its policy framework. Chairman Kevin Warsh has said that the Committee has “pulled back from forward guidance” to obtain a less filtered signal from markets.1 The shift raises the importance of the reaction function: the principles that connect evidence on inflation, employment, output, and financial conditions to policy decisions. The address should make those principles sufficiently clear for markets to assess them against incoming data and subsequent decisions.
The Kansas City Fed will convene the symposium from August 27 to 29 under the theme “Financial Innovation: Implications for Payments and Policy.” Warsh speaks on August 28 in his first Jackson Hole keynote as Chairman.2 The speech will take place within an institutional review that limits the scope for settled framework conclusions. It can still define the standard by which the Federal Reserve’s communications and decisions should be assessed.
Credible Discretion
Discretion requires a public method. A reaction function provides that method by explaining how the Committee relates evidence on inflation, employment, output, and financial conditions to its policy decisions. It gives households, firms, and investors a basis for updating expectations as conditions change. It also preserves the Committee’s capacity to respond when the evidence changes.
Forward guidance can shape expectations about the anticipated path of policy. Warsh’s approach places greater weight on conditional explanation. The Committee need not commit to a future rate path. It does need to explain the evidence that would warrant tighter policy, easier policy, or a continued restrictive stance. A reaction function becomes credible when subsequent decisions are consistent with those stated principles.
EXHIBIT 1: The Conditions Warsh Inherits Inflation sits above the 2 percent objective while long yields hold near multi-decade highs.
| Indicator | Latest reading | Why it matters |
|---|---|---|
| Headline PCE inflation | 3.7% year over year, July 2026 | Above the FOMC's 2% objective |
| Core PCE inflation | 3.3% year over year, July 2026 | A measure of underlying price pressure |
| 10-year Treasury yield | 4.70%, August 24, 2026 | The price of expected nominal short rates plus duration compensation |
| 30-year Treasury yield | 5.23%, August 24, 2026 | The highest since 2007; a measure of duration risk and Treasury absorption |
| Median five-year-ahead inflation expectation | 3.0%, July 2026 | A survey check on longer-run household expectations |
Sources: Bureau of Economic Analysis; Federal Reserve Board H.15; Federal Reserve Bank of St. Louis, FRED (DGS30); Federal Reserve Bank of New York, Survey of Consumer Expectations.3456
Long Yields Resist a Single Reading
Long-term Treasury yields set borrowing costs across mortgages, corporate finance, and public debt, and they shape the financial conditions facing the wider economy. Their level does not identify the source of pressure or establish the appropriate policy response. A nominal Treasury yield can be expressed as the sum of two components:
Nominal Treasury yield≈Expected future nominal short rates + term premium
Expected nominal short rates incorporate expected inflation and the expected path of real short rates. The real-rate path reflects anticipated growth, investment demand, saving, and the expected stance of policy relative to the neutral rate, the real short rate consistent with output at potential and stable inflation. The term premium compensates investors for holding duration amid uncertainty about future rates, inflation, market liquidity, and the supply of Treasury securities.
The decomposition drives the interpretation. A higher expected policy path can signal that markets expect the Committee to hold a restrictive stance. A higher expected inflation path can signal pressure on the nominal anchor. Higher expected real short rates can accompany stronger anticipated growth or demand for capital. A wider term premium can reflect Treasury supply, market functioning, fiscal uncertainty, or uncertainty about the inflation and policy outlook. Several mechanisms can operate at once. Each carries a different implication for policy. The New York Fed's Adrian, Crump, and Moench model estimates Treasury term premia from one to ten years and provides a model-based read on the ten-year yield. It offers no comparable estimate for the 30-year yield, so the yield that draws the most public attention is the one the standard tool cannot decompose.7
EXHIBIT 2: Market Pricing Shows High Real Yields and a Contested Near-Term Path Market measures show elevated real yields, a positive far-forward term premium, and uncertainty around the near-term policy path.
| Measure | Latest reading | Interpretation |
|---|---|---|
| 10-year nominal Treasury yield | 4.70%, August 24 | The combined price of expected short rates and duration compensation |
| 10-year real Treasury yield (TIPS) | 2.38%, August 24 | A high real return required in long-term financing conditions |
| 10-year breakeven inflation | 2.32%, August 25 | Market inflation compensation; includes risk premia and does not forecast PCE |
| Instantaneous forward term premium, 10 years ahead | 1.62%, August 21 | A Kim-Wright estimate of far-forward duration compensation, distinct from the ACM series |
| Futures-implied probability of a September rate hike | 44%, August 26 | Up from about 36% before the July PCE release; a material chance of tightening, not a settled path |
Sources: Federal Reserve Bank of St. Louis, FRED (DFII10, T10YIE, THREEFFTP10); Reuters.891011
The readings describe related market prices, each with a different scope. A precise same-day decomposition is unavailable because the 10-year nominal yield, real TIPS yield, and breakeven inflation rate are observed on different dates and embody distinct liquidity and risk-premium effects. The real TIPS yield reflects expected real short rates as well as real term and liquidity components. The breakeven rate measures market inflation compensation over a ten-year horizon. It does not forecast the PCE index that anchors the Committee’s target.12
The Kim-Wright estimate adds a separate model-based signal. It measures the instantaneous forward term premium ten years ahead, not the term-premium share of the contemporaneous 10-year Treasury yield. The exhibit therefore shows high long-term real yields, a positive far-forward duration-risk estimate, and uncertainty around the near-term policy path. These conditions require the Committee to identify the forces behind higher long yields before drawing conclusions about the stance of policy.
Treasury's August decision to raise the maximum size of long-end liquidity-support buyback operations from $2 billion to at least $4 billion, effective September 9, adds a further consideration.13 The operations are intended to support liquidity in specified long-dated sectors. They can affect market functioning and relative pricing. They do not identify the source of pressure on long yields, and they do not substitute for the Committee's independent assessment of the stance of policy.
Credibility Shows Up as a Pattern
Central-bank credibility is an institutional quality with market and public counterparts. No single data series measures it directly. A useful assessment draws on market pricing, public expectations, and Treasury-market absorption.
Inflation compensation, derived from nominal Treasuries and inflation-protected securities, is one indicator. The Federal Reserve cautions that it does not provide a direct reading of expected inflation, because risk premia affect the measure.12 Survey measures supply a second check. In the New York Fed's July Survey of Consumer Expectations, median five-year-ahead inflation expectations stood at 3.0 percent.5 Treasury auctions supply a third, imperfect indicator of duration absorption. Bid-to-cover ratios, auction tails relative to pre-auction yields, and bidder allocations show how readily the market takes down new supply. A single auction resolves little. A sustained deterioration alongside a rising term-premium estimate would strengthen the inference that investors are demanding greater compensation for duration risk.
The post-speech test is therefore a pattern, not a scorecard. Contained inflation compensation, stable longer-run survey expectations, a moderating ten-year term premium, and a narrower distribution of market-implied policy-rate outcomes would be consistent with a communications regime that has reduced uncertainty. These indicators cannot prove that communication moved markets. Growth data, fiscal news, energy prices, global risk appetite, and Treasury supply can produce the same readings. The pattern can still strengthen or weaken the inference that the Federal Reserve's framework is understood.
The Reaction Function Must Carry the Signal
The withdrawal of forward guidance places the weight of communication on the reaction function, so markets need a disciplined account of how the Committee will convert evidence into decisions as conditions evolve. A legible reaction function need not prescribe a future rate. It should specify how the Committee will judge whether supply disturbances are broadening into persistent inflation; how it will distinguish a rise in long yields driven by term premia from a rise driven by the expected policy path; and what evidence would demonstrate durable progress toward 2 percent inflation. Those principles give markets a basis for updating expectations when data arrive, and they preserve the Committee's authority to depart from a prior market consensus when the evidence warrants it.
Warsh has already supplied elements of that account. In July, he said the Fed had observed a material tightening in nominal and real rates and would assess what those signals implied for inflation and employment.1 He affirmed that higher underlying inflation would make a central banker more inclined to tighten, and falling underlying inflation more inclined to ease. The policy implication stays conditional. Jackson Hole should show how those principles apply when long yields rise for several possible reasons at once.
What the Framework Review Defers
The Federal Reserve has established task forces on communications, balance-sheet policy, data sources, productivity and jobs, and inflation frameworks, mandated to report findings to the FOMC.14 The process makes a comprehensive framework announcement difficult to substantiate before the findings reach the Committee and shape its deliberations. That constraint should improve the address.
Productivity growth and investment may alter the economy's supply capacity. Financial innovation may change payment systems, intermediation, and the operating environment for policy, and the symposium theme makes those questions timely. The timing, scale, and transmission of both depend on institutional design, regulatory treatment, adoption, and market structure, and they remain research questions until the Federal Reserve specifies their operational consequences. The inflation objective supplies the governing constraint. Faster payments, new forms of digital money, and prospective productivity gains change the evidence available to policymakers. They do not by themselves establish a different policy rate, a revised neutral rate, or a changed inflation target.
Bottom Line
The address should be assessed against four commitments: reaffirming the 2 percent PCE objective; explaining how the Committee interprets higher long yields; distinguishing Treasury debt management from monetary-policy judgment; and defining how task-force findings will enter FOMC deliberation. Together they would establish an operating framework for interpreting future data and decisions.
The subsequent test is observable. Federal Reserve statements, decisions, inflation compensation, survey expectations, term-premium estimates, and Treasury-market conditions should converge around a stable account of how policy will return inflation to target. Divergence across those signals would increase uncertainty about the Committee’s method and its reading of financial conditions.
The verdict is straightforward: credible discretion holds only when the Committee keeps its freedom of action while supplying principles clear enough to test against evidence. Jackson Hole establishes the standard; the speech opens the case, and the decisions that follow deliver the verdict.