The Federal Reserve delivered its first interest rate increase in over three years on Wednesday, marking a significant milestone in monetary policy normalization. The decision was unanimous among Fed policymakers, with the central bank raising rates by a quarter-percentage-point to combat persistent inflation pressures. Fed Chair Kevin Warsh, who advocated for the rate hike, delivered hawkish comments following the announcement, reinforcing the central bank's commitment to continued tightening. New policy projections showed 16 of 18 policymakers anticipate at least one more quarter-percentage-point hike by the end of this year, indicating the Fed's commitment to continued tightening. Two-year Treasury yields extended gains as Fed chief Kevin Warsh spoke and hit 4.738%, their highest level since July 2024, while the benchmark 10-year yield reached 5.041% on Tuesday, the highest since 2007. The Fed increased its benchmark overnight interest rate by 25 basis points to a range of 3.75%-4%, marking the first rate hike in over three years.
Benchmark 10-year government bond yields surged to decades-high levels across five major economies this week, marking one of the broadest bond selloffs in years. The US and UK hit marks last seen in 2007, while Japan reached a level unseen since 1996. Germany's 10-year yield climbed to its highest point since 2009, while France's reached a level not seen since 2008. Germany's 10-year government bond yield, the benchmark for the eurozone, was little changed at 3.51% on Thursday, remaining just below its 17-year high of 3.5723% reached on Tuesday. The impact was more pronounced at the shorter end of the German yield curve, with the two-year German yield rising 1.5 basis points to 3.22%. Oil above $100 a barrel is reigniting inflation fears ahead of a cluster of central bank meetings this week, with spikes in oil prices tied to the US-Israeli war on Iran contributing to inflation concerns. According to Reuters, the US Treasury yields influence borrowing costs across the economy, and this global repricing reflects a broader repricing of sovereign risk and inflation expectations.
Bond traders have piled into bearish positions ahead of Wednesday's Federal Reserve meeting, betting that the Treasury selloff driving yields to their highest in almost two decades will continue. Traders in the cash market ramped up their short bets in the past week at the fastest pace since early 2025, according to JPMorgan's Treasury client survey. Investors also increased short positions in Treasury futures both before and after last week's stronger-than-expected inflation report, with open interest data from CME Group Inc. showing this trend. A single bearish block trade in fed funds futures stands to earn — or lose — $1.9 million for every basis point move in the underlying contract. Swaps are pricing some 50 basis points of Fed tightening for the remainder of the year, including September's meeting, as per Citi strategist David Bieber. Bank of America strategists note that positioning remains skewed bearish into the Fed, with shorts having built across the curve and asset managers having largely cut longs or added shorts. Molly Brooks, US rates strategist at TD Securities, noted that "The two-year is going to be moving in tandem with hike pricing," adding that "there's more risk (of) pricing in more hikes than pricing out hikes at this point."
Market expectations for Federal Reserve rate hikes have reached unprecedented levels, with CME FedWatch showing a 92.7% probability for a 25 basis point rate hike at Wednesday's policy announcement, up dramatically from 59.4% a week ago and 33.1% a month ago. As reported by Reuters, markets are now pricing in nearly 100 basis points of hikes over the next 12 months. The rate hike expectations come amid broader global monetary policy shifts, with market rates rising globally due to higher energy prices following the European Central Bank's recent hike. Traders see a more than 55% chance of another increase when the US central bank next meets in October, according to CME FedWatch, up from 53% late Thursday. UniCredit's chief economist Marco Valli expects another Fed rate increase before the end of the year, most likely in December, while monetary policy could remain unchanged next year unless persistent energy price pressures prompt further tightening. Morgan Stanley's Chief U.S. Economist Michael Gapen now expects two hikes of 25 basis points from the Fed this year, in September and December, while Bank of America U.S. economist Aditya Bhave continues to expect 75 basis points worth of hikes from the Fed this year. The U.S. two-year Treasury yield climbed to its highest level in more than two years following the Fed's decision, although it eased slightly to 4.692% on Thursday.
The Bank of Japan raised interest rates to a 31-year high on Friday, signaling a new phase focused on preventing inflation from overshooting its target. The Bank of Japan's governor signaled the central bank has entered a new phase focused on preventing inflation from overshooting its target, marking a significant shift in Japanese monetary policy. The yield on the benchmark US 10-year Treasury note was last up 5.3 basis points at 5.041%, while the two-year US Treasury yield, which typically moves in step with interest rate expectations for the Fed, was last up 5.3 basis points at 4.743%. The yield on the 30-year bond was up 3.6 basis points at 5.332%. The yield curve between 2- and 10-year notes was last at 25.5 basis points, after earlier reaching 23.8 bps, the flattest since June 25. Investors will weigh upcoming data for clues about the US economic outlook, with US factory production unexpectedly fell in August after seven straight monthly increases. US crude oil prices eased on Friday after China, acting on a request from Saudi Arabia, quietly asked Iran to limit attacks by Houthi rebels on Saudi oil infrastructure, with spikes in oil prices tied to the US-Israeli war on Iran contributing to inflation concerns.
