The Federal Reserve has reached a "turning point in history"

"Against the backdrop of the unchanging landscape of the Teton Range, the economic picture we are about to examine at this moment is by no means static."

On local time August 28, 2026, the opening remarks of Kevin Walsh, Chairman of the Federal Reserve, at the Jackson Hole Economic Symposium borrowed the ridgeline formed by hundreds of millions of years of geological movements outside the venue. The mountain is an unchanging reference frame, and what changes is the world discussed by people in the closed conference hall at the foot of the mountain.

From the eve of the 2008 crisis to the decade that followed, the economics circle was still repeatedly discussing "secular stagnation" and "global savings glut" — there was too much capital and too few opportunities, as if "all good things have been invented". At that time, no one could have imagined that the current picture is completely the opposite — capital is pouring into AI (Artificial Intelligence) infrastructure at an accelerated pace. This latest technology, which Walsh called "a technology with an 80-year-old name", is advancing faster than the predictions of its most active advocates just one or two years ago. According to the report cited by Walsh, the annualized token sales of only two artificial intelligence labs have exceeded 100 billion US dollars, a year-on-year increase of more than 500%.

But on the other side of the technology boom is the still untamed inflation. Facing the reality that high inflation has lasted for 65 months, Walsh, who has just taken office for 100 days, cited the assertion of his mentor, George Shultz, an old statesman from the Reagan era: We have come to a "hinge point" in history.

It is not just the US economy that is standing at the turning point, but also the "craft" of central banking itself.

Primary Priority Should Be Price Stability

The Jackson Hole Global Central Bank Annual Meeting has never lacked speeches that have been written into monetary history.

In 2010, then-Fed Chairman Ben Bernanke paved the way for the second round of quantitative easing here; in 2020, then-Fed Chairman Jerome Powell officially announced the average inflation targeting system here; in 2022, Powell told the market in less than 9 minutes that the Fed was willing to endure economic "pain" to recapture the credibility eroded by inflation.

What changes will Walsh bring today?

Before introducing Walsh to the stage, the meeting host described today's financial innovation with the history of the American western pioneer: "In the frontier, the law has not yet arrived." Stablecoins, decentralized finance, AI trading and private credit are extending faster than the regulatory system.

But Walsh really aimed his target at another place — the Federal Reserve itself.

This is no empty polite remark. Walsh then threw out six principles: Data must be fresh, and "yesterday's news" cannot be used to set policies; the judgment of supply-demand balance is inherently inaccurate, and we should not pretend to be very precise; the 2% PCE (Personal Consumption Expenditures) price target is a "firm, fixed" anchor, not a negotiable range; high inflation itself will harm prosperity, and the dual mandate is not a zero-sum game; short-term interest rates are still the main tool, and unconventional measures should be used with caution; "Money matters", and the money created by the Federal Reserve deserves to be taken seriously.

At the meeting, Walsh revisited the concept in the minutes of the July FOMC (Federal Open Market Committee) — changing the regular interest rate meeting frequency from 8 times a year to 6 times to make room for thinking about "strategic issues". Combined with the five working groups he established after taking office (monetary policy communication, balance sheet policy, data, productivity and employment, inflation framework), this "self-revolution" under Walsh's administration is carrying out something that none of the three former Fed chairmen Bernanke, Yellen and Powell have ever done — taking the initiative to take back the microphone.

Its essence is to withdraw from excessive interpretation of the future interest rate path, reduce the intervention of central bank statements on market price formation, return uncertainty to the market, and return policy freedom to the central bank. This set of "excessive communication" paradigm established since the 2008 financial crisis is being systematically dismantled. Walsh believes that the market prices based on Fed guidance, and the Fed in turn reads market prices, eventually forming the "mirror hall effect" he is alert to.

"You can call it an outline, or a roadmap — but please never call it forward guidance." In the territory where old theories have not yet arrived, Walsh gave a meaningful warning.

Let's look at the "tough words" Walsh said: The PCE price index in July rose 3.7% year-on-year, and the core indicator is on the high side. Inflation has been above the 2% target for 65 months — the longest over-target record in half a century.

Walsh did not beat around the bush, he said, "The current primary focus of the Federal Reserve should be prices."

The judgment that opens the door to interest rate hikes is hidden in Walsh's seemingly plain statement: credit spreads are close to historical lows, bank lending standards are in a historically loose range, and corporate capital expenditure is expanding at the fastest pace since 2021 — "It is difficult for me to describe broad financial conditions as restrictive." The subtext is that the current interest rate is not tight enough.

The market quickly understood the signal.

International spot gold prices fell 2.95% to $4,453; Bitcoin fell 3% to $77,837; the probability of a 25-basis-point rate hike in September implied by federal funds rate futures rose from about 1/3 before the speech to 55%-56%. The 2-year U.S. Treasury yield, which is sensitive to policy, rose to 4.35%, hitting a new monthly high. The 10-year and 30-year U.S. Treasury yields also moved higher simultaneously.

A Quieter Federal Reserve

Is this a vote by the market on the Fed's new paradigm?

On the podium in Jackson Hole, Walsh, who has been in office for 100 days, tried to set new rules for the AI era that has entered deep waters with almost cold silence.

Behind this "restraint", there is another clue — AI capital expenditure is shifting from equity narrative to credit expansion. As shown in the minutes of the July FOMC meeting, the credit spreads of hyperscale cloud service providers have further widened relative to investment-grade bonds, redemption applications of Business Development Companies (BDCs) have risen for two consecutive quarters, and the equity risk premium has fallen to the lowest level since the Internet bubble. Walsh said bluntly in his speech: "More than half of the growth in capital expenditure this year may be attributable to AI-related construction."

Although interest rates have not changed, financial conditions have tightened on their own.

Brian Coulton, chief economist at Fitch Ratings, analyzed that this round of 30-year U.S. Treasury yields rising to the highest level since 2007 is not due to the de-anchoring of inflation expectations, but the rise of real yields and term premium. Zhao Yaoting, strategist at Invesco Asia Pacific, believes that the rise in long-term U.S. Treasury yields "has weakened the need for the Fed to raise interest rates further... The bond market is actually achieving part of the goals of the Fed's tight monetary policy."

The market is already "raising interest rates" on behalf of the Federal Reserve. The minutes of the July FOMC meeting show that between the two meetings in June and July, the nominal U.S. Treasury yield rose by 25-30 basis points, and the core driving force was the rise in real interest rates and the repricing of rate hike expectations.

In a sense, this may be the ideal state of Walsh's institutional design: do not pre-announce the rate hike path, so that the market always respects the Fed's possible more hawkish determination. As long as this credibility exists, the risk premium will automatically restrain overheated liquidity.

Walsh discussed artificial intelligence at length, not just to say goodbye to forward guidance, but also because the Fed is facing a new variable for which it does not yet have a mature model — AI as a potential "new factor of production".

AI acts simultaneously on aggregate demand, supply side, as well as total factor productivity, wage pricing, capital formation, asset prices and financial stability. Traditional macro models are difficult to measure its final net effect. In this regard, the "humility" advocated by Walsh is not a philosophical gesture, but perhaps a realistic choice for the Federal Reserve to face the failure of models in the AI era.

A quieter Federal Reserve is likely to become the core footnote to understand the era when Walsh is at the helm of the Fed.

The problem is that the biggest risk of the Fed's self-revolution also comes from the market itself — returning the price discovery right does not mean that the market can always give the correct answer. Strategic ambiguity can maintain policy deterrence, but it may also give rise to unpredictable dramatic volatility premium.

If the 2-year U.S. Treasury yield rises because the market is worried about the Fed raising interest rates, while long-term inflation expectations remain anchored, then this is exactly the result Walsh is happy to see — the market tightens on behalf of the Fed, and credibility is improved instead.

If the market begins to believe that the Fed is not "intentionally maintaining policy options" but "helpless in the fog", the situation will take a sharp turn for the worse. At that time, it will not only be the short-end policy interest rate that jumps. The 10-year and 30-year U.S. Treasuries may also join in higher term premiums. This will exacerbate the rolling financing pressure of the US federal government's $40 trillion debt.

Therefore, Walsh needs to manage two kinds of "ambiguity": one is disciplined uncertainty — the market does not know the next move, but believes that the Fed knows its own goals; the other is unanchored uncertainty — the market begins to doubt whether the Fed still has the ability to steer the monetary cycle.

When Will Discipline Be Delivered

At the end of the speech, Walsh left a sentence worthy of repeated consideration: "What I promise today is a kind of discipline, not a single decision."

On closer inspection, what Walsh wants to change is the entire central bank governance paradigm formed since 2008. Shifting from "the central bank tells the market the future" to "the market judges the future by itself, and the central bank is only responsible for its own mission".

AI is the variable that Walsh wrote the most about in his speech. The minutes of the July FOMC meeting have shown a clear shift — AI is no longer just a productivity story, but has begun to enter the three policy dimensions of inflation, employment and financial stability at the same time.

However, Walsh did not mention two things in his speech: one is the $40 trillion federal government debt; the other is the U.S. Treasury Secretary Bessent's announcement of the expansion of the national debt repurchase plan a week ago.

This is quite puzzling. Right after the Treasury expanded its active management of the long-term Treasury market, Walsh stood at the Jackson Hole Global Central Bank Annual Meeting and told the market: The Federal Reserve needs more real market signals.

Some analysts believe that Bessent is gradually intervening in the policy areas that traditionally belong to the Federal Reserve through a series of measures, making the issue of central bank independence once again the focus of the market. This move comes at a time when the Fed may want to tighten financial conditions to push yields down, creating a potential conflict with the direction of monetary policy.

A paradox at the institutional level thus emerges: when the central bank withdraws from price guidance and the Treasury is increasing intervention in market structure, to what extent can the Fed still observe a "freely formed" long-term interest rate?

Walsh used "restraint" to set the tone for his first 100 days in office: speak less, return discretion to data. But in the face of the Treasury Department personally stepping in to flatten the yield curve, how long can the Fed's verbal "independence" and "restraint" last without being led by the ever-growing bill?

There are less than 20 days before the September FOMC meeting, and the three votes in the minutes of the July interest rate meeting that supported a 25-basis-point rate hike are waiting for Walsh to deliver on "discipline".

"Silence is not only a shield against words, it is a judgment in itself. In all the competition of forces, the most elusive and most destructive are the words that are deliberately hidden." Elias Canetti wrote in the book *Crowds and Power*.

This article is from the WeChat Official Account "Economic Observer", written by Ouyang Xiaohong, and published with authorization from 36Kr.