Federal Reserve’s Interest Rate Decision Could Impact Treasury Yields
On Friday, Josh Hirt, a senior economist at Vanguard, noted that the Federal Reserve’s decision to maintain interest rates during its September meeting might lead to a rise in Treasury yields.
As the Fed prepares for a significant monetary policy meeting this week, there is widespread expectation that the central bank will raise rates due to ongoing inflation concerns.
This year, the Federal Open Market Committee (FOMC) has kept interest rates steady across all five meetings, maintaining the federal funds rate between 3.5% and 3.75%.
Ongoing inflation, which remains above the Fed’s long-term target of 2%, has raised concerns among officials. Consequently, market expectations have shifted towards anticipating a rate hike at this meeting, with the CME FedWatch tool indicating a 92.5% probability for a 25-basis-point increase and just a 7.5% chance that rates will hold steady.
The Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) index, showed a 3.7% increase year-over-year in July. Meanwhile, the core PCE, which excludes food and energy prices, rose by 3.3%. Another significant metric, the consumer price index (CPI), was up 3.4% year-over-year in August, while the core CPI increased by 2.4%.
The expectation for a rate increase is compounded by rising yields on U.S. Treasurys, which have reached their highest levels in years, partly due to competition from foreign sovereign bonds and corporate debt.
Currently, the yield on the benchmark 10-year Treasury note is hovering near 5%, the highest it has been since 2007. This uptick in interest rates affects the federal government’s cost of servicing its debt, influencing the growing budget deficits.
In an interview, Hirt expressed that recent data, including the latest inflation report, could have serious implications if the Fed suspends action on Wednesday. He emphasized that without a strong explanation, the lack of movement might provoke negative market reactions.
While Hirt acknowledged that any immediate adjustments might not be necessary, he suggested that if the Fed were to act, it could ease some market pressure, fostering confidence in their willingness to adjust policy.
He affirmed that the base case would indicate that acting on Wednesday may not lead the market to rise further; rather, it might stabilize or even decrease slightly.
The upcoming FOMC announcement will also include the “dot plot,” illustrating policymakers’ projections on interest rates. However, Fed Chair Kevin Warsh has opted against sharing his outlook, citing concerns over forward guidance.
If the Fed were to announce a rate hike on Wednesday and indicate an upward shift in the dot plot, it could signal to the market a readiness for further adjustments, Hirt remarked. He cautioned, though, that substantial shifts among members’ projections may not be likely.
Following this week’s meeting, there’s an anticipated chance for additional rate hikes later this year, with subsequent FOMC meetings scheduled for October and December, leading into 2027.
According to the CME FedWatch tool, there’s a 49.7% likelihood of two 25-basis-point hikes before the end of the year, putting rates between 4% and 4.25%. There’s also a 28.9% possibility for three hikes, targeting 4.25% to 4.5%, and a 20% chance of just one hike occurring before year-end.
