On the eve of the Federal Reserve’s policy decision, bond traders are on edge. While most expect policymakers to leave interest rates unchanged, prominent voices across Wall Street are putting their weight behind a hike in just the second meeting run by new Chairman Kevin Warsh.
It’s indicative of a new regime at the Fed, with Warsh looking to diverge from his predecessors by no longer signaling interest-rate decisions to markets well in advance. A hike would establish Warsh’s inflation-fighting credibility, leading some, like Citadel Securities and PGIM, to assign a higher chance of an increase Wednesday. For traders, it means greater angst, illustrated by the record demand seen this week to hedge against a surprise rate hike.
“Warsh is still kind of a wildcard, he’s been pretty adamant that he’s not interested in forward guidance,” said Joe Boyle, fixed income investment specialist at Hartford Funds. “He’s not interested in telegraphing anything but maybe something slips, maybe he does do something that’s perceived as forward guidance.”
As of 3:30 p.m. Tuesday in New York, swap-market pricing implied a roughly one-in-three chance that policymakers raise the key benchmark rate by 25 basis points, even as Treasuries headed for their longest gaining streak in a month.
The chorus in favor of the case for a rate hike is growing. In a surprise move, Frank Flight, the head of macro strategy at Citadel Securities, flipped his base case this week to an increase, in what he said “would emphatically end the forward guidance era” while underscoring the Fed’s independence.
Wrightson IC’s chief economist Lou Crandall said there is no good reason for the Fed not to raise interest rates. At PGIM, head of global bonds and chief investment strategist Robert Tipp said the market is probably underestimating the probability of a move Wednesday.
“He has really set the stage for a hike,” Tipp said. “Putting off the decision now would raise the probability to do a 50 in September.”
Bond market veteran Harley Bassman went a step further, arguing in a note Tuesday that the Fed should “rip off the band aid” and raise rates by half a point — a move that would both give it credibility on fighting inflation and fend off pressure from President Donald Trump to lower borrowing costs.
“A 50 basis point hike shows there is a new sheriff in town, and he is not beholden to the President,” Bassman wrote on his financial markets commentary website known as “The Convexity Maven.”
The uncertainty is driving traders to pile on wagers hedging this week’s outcome by a record number. Open interest in the August federal funds futures contract — the number of contracts in which traders hold positions — on Friday topped the record held by the October 2024 contract, reaching 909,714. Data for Monday show a further increase to 967,136.
Since taking the helm, Warsh has vowed to both revamp the Fed’s communications by steering it away from telegraphing its intentions and restoring price stability after inflation has held above the central bank’s target for several years. In his debut press conference last month, he declined to provide specific insight into where he sees rates heading in the coming months.
The rates repricing in recent sessions largely reflects a resurgence in energy prices after the conflict between the US and Iran re-escalated, combined with a resilient labor market. While Treasuries rallied Tuesday as oil prices retreated, traders are still fully pricing a quarter-point hike by September and nearly half a point by March.
“The market is pricing a very real risk that the Fed hikes,” said Mark Cabana, head of US rates strategy at Bank of America Corp. Investors are “still trying to understand how the Fed will function under a Warsh chair.”
The bank’s strategists, led by Cabana, expect the central bank to keep interest rates on hold Wednesday, but attract dissent from Federal Reserve regional presidents Lorie Logan and Beth Hammack, according to a Friday research note. But if the “market won’t rule out hike risk, neither will we,” the strategists wrote.
Since 2015, traders have foreseen the Fed’s ultimate rate decision with an average error of 2.4 basis points the day before the central bank’s announcement, according to a Tuesday note from Ian Lyngen, head of US rates strategy at BMO Capital Markets.
“The market is set up for a sharper kneejerk response to the FOMC announcement than is typically the case,” Lyngen said.
Jonathan Pingle, chief US economist at UBS, said he hasn’t felt this uncertain about an imminent Fed rate decision in 20 years, back when Ben Bernanke became Fed chair. A lack of a track record by Warsh and recent divisions among Fed officials are further clouding the outlook, he said, not ruling out a scenario where Warsh is the one who casts the deciding vote.
“Given the fact that he can push around sort of the median of the committee at the moment, he’s going to decide policy for the next few meetings, and we really have no idea how Kevin Warsh thinks about monetary policy.”
With assistance from Michael MacKenzie and Elizabeth Stanton.
This article was generated from an automated news agency feed without modifications to text.
