Key Takeaways:
New Fed Chair Kevin Warsh faces pressure to raise rates as the long end of the Treasury curve demands reassurance.
New Fed Chair Kevin Warsh likely needs to raise rates soon to reassure the long end of the Treasury curve, Bank of America's chief strategist said, as bond investors doubt the central bank can contain inflation without tighter policy.
"A panicking Fed is just what the bond market needs," Michael Hartnett, chief investment strategist at Bank of America, said in a note dated July 24. "The new chairman probably needs to hike soon to restore credibility with the long end."
The fed funds rate has been held at 3.5% to 3.75% for five consecutive meetings, with the last adjustment predating Warsh's tenure. CME FedWatch data shows the probability of a hike at the July 29 meeting jumped to 38% from 12% a week earlier, driven by a surge in oil prices above $100 a barrel that threatens to reignite inflation. Nearly half of Fed policymakers signaled support for a rate increase later this year at the June gathering, though Warsh declined to submit individual economic projections.
The stakes are high for the bond market. If Warsh holds steady, long-duration Treasuries could face further selling as investors demand a term premium for inflation risk. If he hikes, risk assets from equities to crypto may sell off, but the yield curve could stabilize. "While a July rate hike remains highly unlikely, the September FOMC meeting could become the first meaningful test of whether the recent improvement in inflation proves durable," Gregory Daco, chief economist at EY-Parthenon, said in a July 22 note.
The tension at the Fed reflects a broader shift in market expectations. At the start of the year, many economists forecast at least one rate cut in 2026. Resurgent inflation tied to rising energy costs has flipped that narrative, with some forecasters now expecting higher rates before year-end. Nigel Green, chief executive of deVere Group, said in a July 23 note that "the Fed will find holding steady a harder case to make than it looked even a few weeks ago."
The last time a Fed chair faced similar pressure to act early in their tenure was in 2022, when then-Chair Jerome Powell began the most aggressive hiking cycle in four decades. The S&P 500 fell 19% over the following 12 months as the fed funds rate rose from near zero to above 5%. A comparable move today would imply a fed funds rate above 4.5%, though the current economic backdrop of moderating growth and elevated inflation presents a different challenge.
For the Treasury market, the key question is whether Warsh can anchor long-term yields without disrupting the short end. The 10-year yield has climbed as the probability of a hike has risen, reflecting what Hartnett described as the bond market's demand for "credibility with the long end." A steepening yield curve would suggest investors are pricing in higher future rates, while a flattening would indicate confidence that any tightening remains limited.
The next decision point arrives July 29 at 2 p.m. ET, followed by a press conference at 2:30 p.m. Warsh has vowed to share less forward guidance than his predecessors, making the statement and his remarks the primary signals for markets. The September meeting, scheduled for Sept. 22-23, looms as the next potential inflection point if inflation data continues to run hot.
This article is for informational purposes only and does not constitute investment advice.
