Bond traders ramped up bets that the Federal Reserve will raise interest rates later this month, ahead of a closely watched US inflation report and remarks from Fed Chair Kevin Warsh.
Rising rate expectations are evident both in interest-rate options, where the market-implied chance of a quarter-point hike later this month has climbed to about 50% from less than 10%, and in US government bonds. The two-year Treasury note’s yield, more sensitive than longer-maturity debt to changes in the Fed’s rate, stayed above 4.25% Tuesday, exceeding the policy rate by a widening margin.
The moves accelerated after Fed Governor Christopher Waller — until recently one of the central bank’s most dovish officials — said a rate increase “in the near term” should be considered if the inflation data show “another hot reading” on core prices, which exclude food and energy. “The FOMC has to be ready to tighten monetary policy to prevent a repeat of the 2021-to-2022 inflation episode,” he said.
Bond traders are increasingly anxious it will take higher interest rates to bring inflation back toward the Fed’s 2% target. Oil prices extended gains on Tuesday, with US military forces set to resume blockading traffic to and from Iranian ports and coastal areas. Trump also said the US would keep up attacks on Iran.
Their stress is compounded by Fed Chairman Kevin Warsh’s aversion to making predictions about its course.
Will the Fed resume its rate-hiking cycle?
Short-term interest-rate markets fully price in a Fed rate increase by year-end and a second one by mid-2027 — probably not enough, Al-Hussainy said. He thinks the central bank is likely to unwind all three of the quarter-point cuts it made over the final four months of last year in response to weakening labor-market conditions.
Wagers on near-term Fed rate hikes have flooded into the interest-rate futures market, helping drive up open interest in August federal funds futures. The number of contracts in which traders hold positions has increased about 23% in July. Open interest data are reported after the close, and stand to increase further.
The CPI report is expected to show a 0.1% drop in overall prices from May, bringing the year-on-year rate down to 3.8% from 4.2%. Core prices are seen rising 0.2% from May and 2.8% from last June.
Even softer-than-expected CPI readings may provide limited relief in the bond market, however, where two-year Treasury yields have risen about 10 basis points this month, 10-year yields 15 basis points, wiping out the market’s gains for the year as measured.
