"Anchor of global asset pricing" to arouse another frenzy? Powell is about to take over the Fed. U.S. debt "steep trading" arrow is on the string.

More and more Wall Street senior market strategists have expressed the opinion that if Kevin Warsh, the nominee for the next Federal Reserve Chairman nominated by President Trump, officially takes the helm of the Federal Reserve, the Federal Reserve under his leadership may free the overall trading volume of the US Treasury market of around 31 trillion US dollars from narrow trading ranges. This may urge investors to position for lower short-term US bond yields and a steeper long-term US bond yield curve of 10 years and above. Many strategists and fixed-income fund managers tend to believe that under Warsh's leadership, the Federal Reserve may break the current low-volatility/narrow trading range pattern of the US Treasury market of trillions of dollars and reactivate the "steepening yield curve trading". The core logic behind this is that Warsh may reduce the Federal Reserve's official monetary policy forward guidance, promote balance sheet reduction, strengthen AI-driven productivity reforms, increase policy uncertainty between meetings, thereby increasing the volatility of US bonds; at the same time, if Warsh pushes for continued rate cuts under pressure from Trump in the future, thereby pushing down short-term yields, while balance sheet reduction and somewhat "populist" radical fiscal stimulus leads to a widening fiscal deficit, long-term inflation risks and term premiums supporting long-term yields even further leading to a steeper bond yield curve. During the trading hours on Monday in the Eastern Time Zone, US Treasury yields across all maturities rose by 2 to 3 basis points, still on track to have the narrowest monthly trading range since the end of 2020. As negotiations between the US and Iran to end the geopolitical conflict have stalled, Wall Street strategists generally expect the Federal Reserve to keep benchmark rates unchanged this week. The 10-year US Treasury yield, known as the "global asset pricing anchor", rose by 3 basis points to 4.33%. This low volatility environment, at least in cash bond trading, is prompting strategists to focus on longer-term catalysts in the fixed-income market. This week, Warsh, a former Federal Reserve Board member and also the nominee for Federal Reserve Chairman, will face a vote to formally succeed current Federal Reserve Chairman Jerome Powell, whose term ends in May. The so-called "steeper yield curve betting" is reignited! Warsh intends to "make a major change" at the Federal Reserve. According to a team of senior strategists led by Matthew Hornbach at Morgan Stanley, the Federal Reserve under Warsh's leadership may aim for new inflation indicators and provide fewer monetary policy forward guidance to the market (i.e., the Federal Reserve may not provide economic data forecasts and future rate prospects "dot plot" every quarter as it does now), and accelerate efforts to shrink the balance sheet, etc. These actions "may increase market volatility between each monetary policymaking meeting". He and other senior strategist on Wall Street expect that the Fed policy framework under Warsh's leadership will boost short-term rates, and reactivate the long-dormant "steepening yield curve trading mode". The so-called "old Federal Reserve policy framework" can be simplified as the Federal Reserve operating paradigm that has been strengthened since the financial crisis in 2008 and further enhanced during the epidemic periodviewing the massive balance sheet as the norm, transitioning quantitative easing and long-term debt holdings from crisis tools to semi-regular tools, managing market expectations with abundant reserves, forward guidance, and dot plots, while defaulting the Fed can intervene in the long-term debt and mortgage market for a long period. Warsh advocates for a "new Federal Reserve policy framework" in essence moves rates back to a primary tool, puts the balance sheet back to an auxiliary or even non-conventional tool position. This means QE should only be used in the zero-rate limit or major crisis, gradually reducing the balance sheet during the off-peaking, reducing long-term asset holdings, weakening the Fed's quasi-fiscal role; rebuilding inflation analysis framework, reducing reliance on dot plots and excessive forward guidance, and emphasizing price stability credibility, data quality, productivity and AI structural factors. What Warsh actually wants to do may not be in the traditional sense of "dovish or hawkish monetary policy", but rather a restructuring of the Federal Reserve operation framework: on the one hand, shrinking the balance sheet, weakening the normalcy of QE and quasi-fiscal functions, while using the rate tool more to support the real economy and productivity improvement when conditions allow. In short, he aims at a retreat from the highly leverage and proactive balance sheet-driven policy system of the Fed in the past decade, back to a policy framework more credibility-oriented, price stability-focused, and more emphasized on "currency-based". This is why he reiterates the need for reform in communication mechanisms, inflation framework, reducing forward guidance, and describing extensive asset holdings as more "Wall Street" rather than "Main street". As shown above, the short-term yield trading in the US Treasury market still remains above the upper limit of the Federal Reserve rate, indicating a greater possibility of a steepening yield curve in US Treasury yields. However, currently, the global bond market has largely remained stable after falling due to the stagflation expectations caused by the high oil prices resulting from the Middle East geopolitical conflict last month. High oil prices are seen as bringing new inflation risks; if these risks persist, they may eventually harm economic growth and continued economic drag, leading to the feared "stagflation" scenario for the Federal Reserve. Wall Street strategists and fixed-income market fund managers will closely monitor the speech of Federal Reserve Chairman Powell after this week's monetary policy decision to look for any clues regarding how the Fed assesses the economic impact of the geopolitical war. Interest rate futures traders seem to believe that the Federal Reserve will cut rates once before the end of the year. The current market pricing indicates that, before the December Federal Reserve monetary policy meeting, traders are gradually factoring in a 25 basis point rate cut expectation. Rate cuts are usually seen as significantly lowering short-term yields and helping expand the difference between the short-term yield and the longer-term yield curve, i.e., the 10- and 30-year US Treasury bond yield curve, thus pushing the yield curve to steepen. Robert Tipp, the Global Bond Director and Chief Investment Strategist at PGIM Fixed Income, stated that Federal Reserve officials "will try to buy time as they see the US economy still quite strong, but inflation remains above target." "They will want to avoid disrupting the market and causing an unexpected tightening of the financial environment, so they may maintain monetary policy status quo for a long time, i.e., maintaining the benchmark interest rate unchanged for a long time." Currently, he believes that short-term US Treasury bonds face risks depending on the transmission of economic data from geopolitical conflicts. Investors will also focus on the preferred inflation indicator reading that the Federal Reserve will release on Thursday namely the core PCE inflation indicator. Jack McIntyre, Portfolio Manager of Brandywine Global Investment Management, said, "This week we are unusually facing a mix of headlines related to the Iran-US ceasefire negotiations, crucial economic data, global central bank interest rate decisions, and major tech giants' earnings reports such as Google and Microsoft. Any unexpected fluctuations in any one of these dynamics could disrupt the market." "If the Federal Reserve wants to dramatically shift market expectations in a certain direction through verbal guidance, the bar is very high." Warsh steering the Federal Reserve, what does it mean for the "global asset pricing anchor" and the AI-driven global stock market boom? If Warsh takes the helm of the Federal Reserve, the core implication for the US bond market is not simply "rate cuts are good for bonds", but that the policy response function may be re-priced by the fixed-income market: fewer forward guidance, a greater emphasis on new inflation indicators, a smaller balance sheet, and narrower policy responsibilities. This will shift the market from "listening to early policy path and framework cues from the Fed in advance" back to a state of "repricing at each meeting," meaning that front-end rate volatility may increase. According to media reports, Warsh clearly advocated for coordination with the Treasury Department to shrink the Fed balance sheet and criticized the expansion of the balance sheet becoming a repeatedly used regular force; at the same time, he believed that if the Fed downsizes its balance sheet, rates could be lower, inflation could be better, and the economy could be stronger. If in the future the Fed replaces some tightening functions with a smaller balance sheet, short-term yields may decline due to rate cut expectations; however, long-term rates will face three upward forces: the Fed reducing bond holdings means a reduced official need for long-duration assets, fiscal deficits and government bond supply pressures persist, oil price shocks make inflation risk premiums hard to disappear quickly. The Fed's balance sheet reduction measures will undoubtedly significantly reduce total demand, push up long-term US Treasury bond yields, but the economic consequences of the Iran war will prompt the US government to take "some form of populist measures to help households and businesses. In addition, with Trump possibly pressuring Warsh for rate cuts, short-term yields may be lower due to this comprehensive set of measures, which is the underlying mechanism behind Wall Street's renewed betting on the "steepening yield curve". The 10-year US Treasury bond yield, known as the "global asset pricing anchor," if it continues to rise due to term premium drive by fiscal stimulus, will undoubtedly lead high-yield corporate bonds, technology stocks driving global stock market boom, those risk assets closely linked with AI, and even cryptocurrencies, to face a new round of valuation collapses. If the 10-year and longer US Treasury bond yields continue to rise, for stock markets, cryptocurrencies, and high-yield corporate bonds, it means "significant rise in cost of capital + weakening liquidity expectations + expansion of macro denominator" all occurring at the same time. From a theoretical perspective, the 10-year US Treasury bond yield is equivalent to the risk-free rate indicator r in an important valuation model in the stock market the DCF valuation model's denominator. If other indicators (especially the numerator end, such as cash flow expectations) do not change significantly such as in a financial reporting season, when the numerator end lacks positive catalysts and remains in a vacuum, when the denominator level is higher or operates at historical highs, valuation will be at a historical high for those "AI-related tech stocks, high-yield corporate bonds and cryptocurrencies" at the mercy of AI fever. However, as Warsh bets on AI productivity dividends and aims to perform structural surgery on the Fed, the global stock market boom trajectory is unlikely to be directly ended; it will likely shift from liquidity-driven comprehensive revaluation to profit-realization-driven differentiated market, and within this process, as the global asset pricing anchor the steeper 10-year US Treasury bond yield increasing the trajectory lower volatility is likely unavoidable. Truly benefiting from cash flow, real traffic, pricing rights, and capital spending chains from AI horsepower infrastructure companies, and those software giants, solid fundamentals that aggregate data assets and "AI + core operational processes," may still traverse the environment of higher interest rates. Warsh's criticism of the potential runaway inflation in 2021-2022, his firm stance on the need to rewrite the "inflation framework," and his high regard for AI productivity dividends are all on the same line: He is betting that the way to lower future inflation is no longer to continue expanding the balance sheet to support assets and revive markets but to rely on technological progress, improved productivity, and a more restrained central bank balance sheet to rebuild monetary credibility. However, stocks with high valuations, low profits, and multiple expansion driven by narratives are more susceptible to suppression by the 10-year US Treasury bond yield and actual rates. In other words, Warsh is not the "terminator of the AI bull market narrative", but may be the critical macro variable that shifts the AI market from "indiscriminate frenzy" to "high-interest rate selection tournament". If the 10-year US Treasury bond yield remains high due to term premium rises or bond volatility increases, the forward cash flow discount of AI-related tech stocks will become more demanding, especially putting pressure on those "AI concept assets" that rely on future profit realization and free cash flow verification. Sincerely, [Your Name]