Bond traders are demanding extra compensation to hold Treasurys due to uncertainty about Federal Reserve Chair Kevin Warsh's policy stance, according to Robert Kaplan, former president of the Dallas Federal Reserve and vice chairman at Goldman Sachs.
Kaplan told CNBC that markets have struggled to interpret Warsh since his September press conference, as the Fed chair declined to submit his own interest rate projection. This uncertainty has prompted traders to add what Kaplan describes as a risk premium to Treasury yields.
Rising Treasury Yields
The 10-year Treasury yield has climbed to approximately 5.25%, near its highest level since 2007. This represents a rise of more than 100 basis points compared to a year earlier. Kaplan links part of this increase to the Warsh premium.
The Federal Reserve raised rates by 25 basis points to a range of 3.75% to 4% on September 16, marking its first rate hike since 2023. The Fed's updated dot plot indicated one additional increase could occur before year-end, though markets have priced in more tightening than the Fed projected.
Additional Pressure on Yields
Kaplan identified a second driver affecting yields: elevated diesel prices resulting from geopolitical tensions. Ukrainian strikes have left approximately half of Russia's refineries offline or damaged, while diesel costs are already spreading into numerous consumer items.
Melissa Brown, global head of investment decision research at SimCorp, noted that the Fed has limited control over supply-side inflation factors such as fuel costs.
Rate Hike Outlook
Kaplan said he would prefer the Fed skip a rate hike in October and revisit the decision in December. This view aligns with comments from New York Federal Reserve President John Williams, which helped cool market expectations for an October increase.
Despite market pricing, Kaplan doubts the bond market has accurately assessed the Fed's intentions. "I think the market may be overestimating what the Fed actually does, but time will tell," he told CNBC.
Calmer oil and diesel prices could help Treasury yields ease, Kaplan suggested. Higher yields typically put downward pressure on risk assets.
