Something odd is happening in the bond market. Yields on US government debt just hit levels nobody has seen in nearly two decades, and it all started when the new Federal Reserve chair decided to keep his mouth shut.
Kevin Warsh, the freshly appointed Fed chair, announced no change to interest rates and declined to offer any clues about what comes next. Investors responded by selling off Treasuries in a hurry. The 30-year bond yield touched 5.24 percent, its highest level in 19 years. The 10-year yield jumped to 4.71 percent right after the announcement.
The logic goes like this: If the Fed is not raising rates and will not signal future moves, then maybe it thinks inflation is under control. But investors are not so sure. Oil prices have already shot above $100 a barrel this month as the Middle East conflict escalated. On the day of the announcement, Brent crude briefly hit $92 and US crude touched $85 before pulling back.
"The disconnect between the Fed's stated commitment to price stability and its decision to remain on hold has raised questions about the consistency of the policy message," said Seema Shah, Principal Asset Management's chief global strategist. "Market reaction reflected this uncertainty."
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Aditya Bhave, Bank of America economist, put it even more bluntly: "Markets responded by questioning the Fed's credibility."
Ed Yardeni, a longtime market observer, pointed to the "bond vigilantes" stepping in. His take: If the Fed will not keep inflation in check, the bond market will do the job itself by pushing yields higher and tightening financial conditions.
Rising bond yields are bad news for stocks, especially the tech names that led the market higher for years. The Nasdaq 100 closed more than 10 percent below its all-time high. It was also the sixth straight day of losses for the index, the longest losing streak since 2022.
A separate data point shows just how worried traders are about inflation. According to the CME FedWatch tool, the probability that the Fed will raise rates by 25 basis points in September sits at 59 percent, up from 57 percent the day before. The shift is small but telling. Investors are starting to bet that Warsh will eventually have to hike to prove he is serious.
All of this points to a tricky moment for anyone with money in the market. The Fed seems stuck between two bad options. If it raises rates, it risks slowing the economy too much. If it holds steady, it risks letting inflation rekindle - and the bond market will punish that choice by pushing yields even higher.
Researchers at BNP Paribas characterized Warsh's strategy as "Odyssean" loose guidance, implying that he is pledging future rate increases in return for reduced inflation now. But without any actual action on rates, they warned, the market will continue to discount the Fed's credibility.
Some analysts are looking back at the 1970s, when the Fed cut rates too early and inflation later surged to a higher peak. That comparison is not meant to scare you. It is just a reminder that the path forward is uncertain.
The next big date to watch is the Fed's September meeting. Aditya Bhave from Bank of America wrote that "the need to re-establish credibility increases the probability that the Fed will hike in September, all else being equal."
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