The Fed meeting is a pivotal moment for the bond market

By John Towfighi, CNN

New York (CNN) — The bond market sell-off is raising the stakes for the Federal Reserve’s monetary policy meeting this week and putting a spotlight on the central bank’s commitment to reining in inflation.

Traders widely expect the Fed to raise its benchmark interest rate on Wednesday for the first time since 2023. Traders are pricing in a 93% chance of a rate hike, according to CME FedWatch, a real-time forecasting tool.

If the Fed surprises markets by holding rates steady, it could accelerate the bond market sell-off that’s pushed up yields in recent weeks, analysts say. If the Fed raises interest rates by a quarter point, matching the market’s expectation, traders will still be scrutinizing remarks from Chairman Kevin Warsh.

The 10-year Treasury yield rose Tuesday and briefly touched its highest level since 2007, highlighting the sensitivity of the moment for markets. A mosaic of concerns are sending bond yields to multi-year highs.

For weeks, markets were highly uncertain about whether the Fed would raise rates or hold them steady this month, and odds fluctuated around 50% for each outcome. But after data released on Friday showed that consumer inflation remained sticky in August, traders began to shift their bets toward a rate hike.

Now, if the Fed holds rates at their current levels, there could be a sell-off in bonds as investors question whether the central bank is doing enough to tamp down inflation that has worsened since the start of the war with Iran.

Treasury yields have marched higher this year amid a global bond market sell-off, pushing up borrowing costs for consumers, businesses and the US government.

If the Fed is unable to convince investors it is serious about reining in inflation, bond yields may move even higher, putting more of a pinch on consumers and the government and threatening to rattle the stock market.

“At this stage, it would be very difficult for the Fed to leave rates unchanged this week without eroding its inflation-fighting credibility,” Vail Hartman, US rates strategist at BMO Capital Markets, said in a note.

“Historically, the Fed has seldom deviated from rate decisions that markets have priced with such high conviction,” Hartman said. “Surprising with a hold would trigger a sharp rally in the front end of the curve and a sell-off in longer-dated Treasuries, [the] US dollar and risk assets.”

Bond prices and yields move in opposite directions: When investors sell bonds, prices fall and yields rise.

Rising yields send Warsh a message

At the Fed meeting in July, Warsh said he wants markets to move based on economic data and not just trying to game the Fed’s next decision.

He acknowledged the rise in Treasury yields at the time and said it was based on “market attention centered on real data and real economic developments,” welcoming the move.

“Market participants are learning to play the ball, not the referee — and market prices will continue to respond in the direction and magnitude they see fit,” Warsh said on July 29. “This is, in my view, a change for the better — and we’re just getting started.”

Since that Fed meeting, Treasury yields have continued to climb. The 10-year yield closed at 4.6% on July 29, and is now trading at 5%, near levels not seen in nearly two decades.

The two-year Treasury yield, which tracks expectations for Fed policy, is at its highest level in over two years, and about a full 100 basis points (1%) higher than the Fed’s benchmark interest rate.

Warsh said on July 29 that he wants to get an “unfiltered message from markets.” Now, markets are betting that the Fed will raise rates on Wednesday.

“[Warsh] has been talking hawkishly since June. Now, he has to deliver a rate hike,” Ed Yardeni, president of Yardeni Research, said in a note.

“After all, he promised to follow the financial markets’ lead. The 2-year and 10-year yields are clearly calling for a rate hike,” Yardeni said. “If they keep rising after Warsh’s presser on Wednesday, then he will still have a credibility problem.”

Yields have climbed this year for a variety of reasons, including rising corporate debt issuance, mounting government debt, nerves about inflation, expectations for central bank rate hikes and general policy uncertainty tied to the conflict in the Middle East.

At MUFG, head of US macro strategy George Goncalves said he originally expected the Fed would hold interest rates steady in September, but changed his call to a hike in response to factors including last week’s hotter-than-expected inflation report.

Goncalves said in a note that even though he thinks a rate hike might not even be the correct policy move, not doing anything would be “problematic,” given Warsh’s repeated comments that “inflation is a choice” and the Fed is committed to bringing it down to its 2% target.

“Warsh gave the market a vote on when the Fed should move, and the market has now definitively voted for September,” Stephen Myrow, managing director at Beacon Policy Advisors, said in a note.

The-CNN-Wire
™ & © 2026 Cable News Network, Inc., a Warner Bros. Discovery Company. All rights reserved.