The Federal Reserve plans to reduce the number of annual interest rate decisions Wall Street warns: Volatility in the $32 trillion US bond market is likely to intensify

The Zhitong Finance App learned that Federal Reserve Chairman Walsh plans to gradually reduce the number of interest rate decisions from eight to six per year, raising Wall Street's concerns about increased volatility in the US Treasury bond market. Investors warn that as the Federal Reserve reduces the frequency of policy decisions and gradually dilutes forward-looking guidance on future interest rate paths, the $32 trillion US Treasury bond market may face greater policy uncertainty, and fluctuations in bond yields may expand as well.

Walsh announced the reform plan after the Federal Reserve announced on Wednesday that interest rates would remain unchanged. According to the arrangement, the Federal Reserve will reduce the number of interest rate decisions to seven in 2027, then further to six per year. The remaining two meetings will mainly be used to discuss broader strategic issues.

Walsh said the move was aimed at providing policy makers with more time and space to study major economic and monetary policy issues in greater depth. However, market participants worry that reducing the number of interest rate decisions may have the opposite effect, making the Fed's policy adjustments more difficult to predict.

Decrease in the number of decisions or amplification of market fluctuations, and the risk premium on US bonds is under upward pressure

Traders pointed out that as the interval between interest rate decision meetings lengthens, the Federal Reserve may need to take more drastic interest rate hikes or interest rate cuts at individual meetings to cope with the economic changes accumulated during the period. At the same time, if the economy or financial markets suddenly experience a major shock, the possibility that the Federal Reserve will take urgent policy action outside of a regular meeting may also increase.

These changes may not only increase short-term US Treasury yield fluctuations, but may also prompt investors to demand higher risk compensation, thereby boosting long-term bond yields.

Isaac Wheeler, managing director of balance sheet strategy at financial derivatives services firm Derivative Path, said: “This is the clearest signal so far that the Federal Reserve under Walsh has no intention of continuing to act as a suppressor of interest rate market fluctuations. The Federal Reserve is fully willing to increase market volatility through unexpected policy announcements if the situation requires it.”

Scott DiMaggio, head of fixed income at AllianceBernstein, also believes that reducing the number of interest rate decisions may have a long-term impact on the US Treasury yield curve. He pointed out that if the Fed's policy adjustments become more abrupt, the market will need to take into account a higher risk premium for possible drastic fluctuations in the future. “In the long run, the yield curve will include more risk premiums as a result of these volatile events.”

Short-term US bonds rose, and the yield curve steeper under pressure on long-term US bonds

It is worth noting that the Federal Reserve's plan to reduce the number of interest rate decisions may have a very different impact on US Treasury bonds with different maturities. Traders believe that in the current context where the Federal Reserve is still expected to raise interest rates further to contain inflation, reducing the number of policy decisions may mean that the opportunities for the central bank to take austerity measures are reduced accordingly.

This may reduce market expectations for further increases in short-term interest rates, thereby favoring short-term US Treasury bonds. However, rising policy uncertainty may push up the risk premium on long-term bonds, making long-term US debt performance relatively weak.

On Wednesday, after Walsh announced his reform plan and released dovish signals at a press conference, the price of short-term US Treasury bonds rose and yields fell. In contrast, the poor performance of long-term US Treasury bonds is driving the US bond yield curve steeper.

The data shows that since Wednesday, US 30-year Treasury yields have risen by about 10 basis points compared to two-year Treasury yields. This change reflects that, on the one hand, investors have lowered their expectations for short-term policy interest rates, and on the other hand, they have begun to demand higher risk compensation for the uncertainty of long-term monetary policy.

Walsh pushes forward guidance on the reform of the Federal Reserve's communication mechanism or gradually fades out

Reducing the number of interest rate decisions is only part of Walsh's push to reform the Federal Reserve's monetary policy communication mechanism. Since taking office as Chairman of the Federal Reserve in May of this year, Walsh has always emphasized the need to push for fundamental changes in the central bank's policy framework and promised to bring about an “institutional change” to the Federal Reserve. He believes that the Federal Reserve's excessive reliance on forward-looking guidance may limit policymakers' ability to adjust interest rates flexibly according to changes in the economic situation.

Walsh argues that such policy communication tools should be kept mainly used during special periods such as economic crises, and should not become an important part of conventional monetary policy. To this end, he has set up a special working group to study the Federal Reserve's communication strategy, including press conference arrangements and a bitmap system reflecting official interest rate expectations in the future.

Walsh first proposed the idea of reducing the number of interest rate decisions at the US Federal Reserve meeting in July of this year, and officially announced the relevant adjustment plan on Wednesday. He said that the new meeting schedule will enable policy makers to rethink some major issues without having to discuss whether to adjust interest rates at every meeting.

Kerry Craig, global market strategist at J.P. Morgan Asset Management, believes Wednesday's announcement marks the Federal Reserve's entry into a new era of policy communication. He said that this means that the Federal Reserve is beginning to shift to a model of reducing early release of policy signals, and there may be more adjustments in communication mechanisms in the future.

Short-term effects or limited but long-term volatility risks have not been fully taken into account by the market

Despite investors' concerns about the reform plan, the market's response to its short-term impact is still relatively limited. Traders pointed out that some indicators measuring expectations of interest rate fluctuations in the next two years have hardly changed. One reason is that the Federal Reserve has yet to announce all the details of the new meeting schedule.

Currently, the Federal Reserve has only stated that it will change a meeting in the fall of 2027 to specifically discuss strategic issues, but it is not clear exactly which one. Traders and economists generally agree that the October meeting is most likely to be adjusted because the conference originally did not schedule quarterly economic forecasts.

Furthermore, the market currently generally anticipates that the Federal Reserve will end this round of interest rate hikes after one year.

Overnight index swap market pricing shows that interest rate expectations for the period September to December 2027 are largely flat. This means that even if interest rate decisions are not scheduled in October, the direct impact on the market's short-term interest rate expectations may be limited.

However, investors warned that the combination of reducing the number of interest rate decisions and diluting forward-looking guidance may have a more profound impact on the future US bond market.

Ali Hassan, portfolio manager at Thornburg Investment Management, said: “Fewer interest rate decision meetings, combined with a lack of forward-looking guidance, will cause the market to reprice more drastically before and after each policy meeting, and cause interest rate fluctuations to exceed current market expectations.”

Overall, the reforms promoted by Walsh are aimed at improving the flexibility of the Federal Reserve's policy formulation, but it also means that it may be difficult for investors to judge the central bank's policy actions in advance in the future as in the past.

For the $32 trillion US Treasury bond market, the decline in predictability of the Federal Reserve's policy may become an important factor driving interest rate fluctuations and the rise in risk premiums on long-term bonds.