Summary of Key Points
Since August 2026, there has been a stark conflict between the policy stance of Federal Reserve Chairman Jerome Powell and market reactions: he took a hawkish stance at the Jacksonhole annual meeting, promising to address inflation. However, as the situation in the Middle East deteriorated and drove up oil prices, he did not allow short-term interest rates (2-year U.S. Treasuries) to bear more of the inflationary pressure, leading to market distrust. As a result, the yield on 10-year U.S. Treasuries soared to 4.81%, the highest level of the year. The core issue is that Powell is trying to regain control over short-term interest rate pricing and tighten financial conditions, while Wall Street resents losing this influence and expresses its dissatisfaction by driving up long-term bond yields.
Detailed Analysis
1. Why are 10-year U.S. Treasury yields considered a "tightening tool" for the economy?
Ordinary people might ask, "What does it matter if a bond yield rises?" In fact, bond yields serve as an indicator of the economy's "tightening or loosening" environment because they account for 45% of the Financial Conditions Index (a comprehensive measure of how difficult it is to borrow money and the cost of borrowing). This is more significant than credit spreads (37%) or exchange rates (6%). The reason for this high weight is that long-term bond yields reflect the risk of government debt repayment (sovereign credit risk). If investors believe there may be problems with the U.S. government's ability to repay its debts, long-term bond yields will rise, and this risk can be transmitted to businesses and individuals. Higher borrowing costs for businesses and higher mortgage rates for individuals increase the overall economic "tightness." Therefore, a rise in long-term bond yields is like imposing a tightening constraint on the economy.
2. The "seesaw" relationship between short-term and long-term bonds: When does it reverse?
Under normal circumstances, short-term (2-year) and long-term (10-year) bond yields move in the same direction. When the Federal Reserve raises interest rates, short-term bond yields rise, and long-term bond yields also rise, indicating a tightening of financial conditions. However, in "special boundary situations" (when markets start to worry about the government's debt repayment risk), the two become inversely correlated:
- If the Federal Reserve is hawkish (high short-term bond yields), it indicates that the Fed is willing to take on risk, and market concerns about long-term bonds decrease, leading to lower long-term bond yields.
- If the Federal Reserve is dovish (low short-term bond yields), the market assumes the government is not taking on enough risk, and long-term bond yields rise to reflect this increased risk.
In this case, Powell did not allow short-term bond yields to rise significantly, so long-term bond yields were driven up by the market.
3. The two main reasons why Wall Street dislikes Powell
There are two main reasons why Wall Street dislikes Powell:
- Reason 1: Taking control of short-term interest rate pricing: Previously, under the abundant reserves system, the market and the Federal Reserve jointly determined short-term bond yields. Now, with the new scarce reserves system, the Federal Reserve is setting short-term bond yields on its own, leaving Wall Street with no say—this shift from a collaborative approach to a more autocratic one is highly unpopular.
- Reason 2: Tightening financial conditions: Powell believes that current borrowing costs are not high enough (for example, business loan conditions are relatively loose), so he wants to tighten financial conditions. However, Wall Street prefers a loose environment (easier borrowing and more profit-making opportunities), which makes them opposed to his policies.
4. Why did Powell's "hawkish promises" fail?
Powell stated at Jacksonhole that the Fed would address inflation in a timely manner. However, despite rising oil prices, short-term bond yields only increased from 4.35% to 4.40% (a mere 0.05%), indicating that he did not believe current financial conditions were tight enough. If short-term bond yields had risen more, it would have led to higher long-term bond yields, which would have achieved his goal of tightening financial conditions. The market disagreed with this approach, believing that his promises to combat inflation were not being fulfilled. As a result, the market voted with its feet, pushing 10-year Treasury yields to a new high, signaling, "We don't believe you can control inflation; therefore, long-term bond yields must rise even more."
5. The Middle East situation exacerbates the issue: Oil prices as the "last straw"
The deterioration of the Middle East situation has pushed oil prices above $95 per barrel, increasing inflationary pressure. According to Powell's approach, short-term bond yields should have risen to absorb this pressure, but they did not. Instead, the entire inflationary burden fell on long-term bonds. The rise in long-term bond yields reflects not only sovereign credit risk but also inflationary expectations caused by rising oil prices, exacerbating the situation and reaching a new high this year.
In one sentence
Powell is not an amateur, but his goals (tightening financial conditions and regaining control) are completely at odds with Wall Street's interests (loose financial conditions and greater influence). Therefore, the market has responded by driving up long-term bond yields as a form of resistance to his policies. The recent Middle East crisis has merely magnified this conflict.