Three Fed dissents signal September rate hike as long bond yields surge
A split Federal Reserve kept interest rates unchanged but internal pressure to tighten pushed long-dated Treasury yields to 2007 highs and sharply increased the probability of a September rate hike.
The Federal Reserve left its benchmark rate in the 3.50 to 3.75 per cent range on Wednesday. However, three regional bank presidents dissented in favour of a quarter-percentage-point increase. The split vote reveals a deepening divide at the US central bank over how to combat persistent inflation.
The policy statement noted that economic activity is expanding at a solid pace and the labour market remains tight. It warned, however, that inflation remains elevated relative to the 2 per cent goal.
Fixed-income markets reacted violently to the prospect of prolonged tight policy. The Treasury yield curve steepened sharply as two-year yields fell while longer-dated debt sold off. The 30-year bond yield crossed above 5.20 per cent for the first time since 2007, reflecting investor anxiety over structural price pressures.
Traders shifted their bets immediately after the decision. The probability of a September hike jumped to 57 per cent, according to CME Group's FedWatch tool, up from near certainty for a hike only hours before.
Fed Chair Kevin Warsh offered no explicit outlook for rates but welcomed the market repricing. "I was comforted that markets in the inter-meeting period weren't reacting to us" and that traders relied on their own judgment, he said.
Warsh reiterated his pledge to defeat inflation that has run above target for more than five years. "This Fed will not waver" on getting inflation back to the 2 per cent target, he stated, adding the central bank will not hesitate to act where appropriate.
The three dissenting officials from Cleveland, Dallas and Minneapolis previously broke with the board in April. Their repeated calls for tighter policy highlight a belief that current borrowing costs are insufficient to cool an economy boosted by artificial intelligence investment and energy supply shocks.
Analysts see a clear path to higher rates. "At this stage, I think we should expect the FOMC to hike rates by 25 basis points in September unless the labour market data collapses," said Omair Sharif of Inflation Insights. Kathy Bostjancic of Nationwide noted that "the high number of dissents underscores that policymakers are increasingly more hawkish."
The hawkish stance complicates the political dynamic. President Donald Trump has desperately sought rate cuts but told reporters on Wednesday: "He's a brilliant guy." Trump added that Warsh faces a "political board" that wants to keep rates up.
