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- The Federal Reserve is widely expected to raise its benchmark interest rate on Wednesday, marking a sharp turnaround for an economy increasingly shaped by the war in the Middle East.
- Inflation has been above the Fed’s 2% target for almost half a decade and has worsened since the start of the war with Iran.
- That’s leading officials on the central bank’s influential rate-setting committee toward the first rate hike since 2023, a move designed to cool spending and prevent inflation from becoming more entrenched.
- Raising rates could also weaken an economy that is already showing signs of strain, pushing up the cost of borrowing for consumers and businesses. However, keeping rates steady could rock the bond market, sending the Treasury rates that influence mortgages dramatically higher and spooking the stock market.
Bond market milestone raises stakes for Fed decision
The 10-year Treasury yield settled near 5% on Tuesday, its highest closing level since 2007. That milestone raises the stakes for the Federal Reserve rate decision.
The bond market has sold off this year amid nerves about inflation and other concerns. As focus turns to the Fed decision, investors want reassurance that the central bank is serious about reining in inflation.
Traders overwhelmingly expect the Fed to raise its benchmark lending rate on Wednesday. Odds for a hike rose above 90% after core inflation data released Friday was slightly hotter than expected.
If the Fed raises by a quarter point, matching expectations, investors will be keen to gauge whether it’s the start of a series of hikes and how the Fed is viewing its inflation mandate. If investors feel confident in the Fed, that could keep yields contained.
But if the Fed surprises markets by holding rates steady, it could trigger a bond sell-off. If the Fed doesn’t convince investors that it is serious about reining in inflation, bond yields on the long end of the yield curve (10-year to 30-year) could move higher.
“We’ve heard the Fed talk the talk [on inflation], and then potentially be perceived as not walking the walk,” Chip Hughey, managing director for fixed income at Truist Advisory Services, told CNN.
“That might make the long end nervous if there is not a hike delivered today,” he said. “I would expect the long end to move higher if the Fed stands pat.”
Yields were lower Wednesday morning ahead of the Fed rate decision, pulling back after rising to multi-year highs to start the week. Oil prices also fell more than 3%, easing pressure on bonds.
The inflation data that may have sealed the case for a rate hike
Before last week’s inflation reports, traders – both on prediction market sites and in the CME FedWatch forecasting tool – were wavering back and forth as to whether they believed the Federal Reserve would hike interest rates or hold.
After Thursday’s Producer Price Index report was released, traders started leaning toward a hike. By the time Friday’s Consumer Price Index report came out, there was barely any doubt left that the Fed was going to hike.
Here’s what the two reports showed and why they matter to the central bank:
- The index, which tracks price changes received by US producers and manufacturers, increased 5.4% in the 12 months that ended in August. That was a 0.6% acceleration from 4.8% in July.
- Prices for goods alone rose 1.1% last month, a huge jump from July’s 0.4% decline. More than three-quarters of that increase came from rising energy costs.
- Why it matters to the Fed: PPI is seen as an important indicator for how consumer prices could move in coming months, since businesses are typically the first to see price increases.
- Consumer prices rose at a 3.4% annual rate last month, the same pace as July.
- On a monthly basis, prices rose 0.4%, an acceleration from July’s 0.1% rate. Gasoline prices, up 3.9%, accounted for one-third of the monthly price increase.
- Even when excluding food and energy, prices were up 0.3% versus 0.2% in July.
- Why it matters to the Fed: The report is a sign that price increases are becoming more broad-based.
Traders put odds of Fed rate hike at 93%
From the market’s perspective, the Federal Reserve decision on Wednesday is already locked in. Traders are pricing in a 93% chance that the Fed raises interest rates by a quarter point, according to CME FedWatch, a real-time forecasting tool.
If the Fed were to hold rates steady, it would come as a major surprise to markets – and could stoke volatility.
“Historically, the Fed has seldom deviated from rate decisions that markets have priced with such high conviction,” Vail Hartman, US rates strategist at BMO Capital Markets, said in a note. “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.”
Read more here.
When was the last time the Fed hiked?
Federal Reserve officials have in recent years avoided raising their benchmark lending rate, wary of doing unnecessary damage to the economy.
But now, as the central bank prepares to raise rates to battle inflation tied to President Donald Trump’s war with Iran, the debate has shifted from whether to hike to how many hikes will be required this cycle.
Here’s a look at Fed rate decisions from the past decade:
Stocks are mixed ahead of Fed rate decision
Stocks were mixed shortly after the opening bell on Wednesday as traders await the Federal Reserve’s decision on interest rates.
The S&P 500 rose 0.3%. The Dow fell 40 points, or about 0.1%. The Nasdaq Composite gained 0.45%. Traders will be waiting to see how the Fed decision and Chairman Kevin Warsh’s remarks this afternoon impact markets.
The major indexes are each down six of the past seven trading sessions. Stocks are under pressure as bond yields rise to multi-year highs and global oil prices continue to trade above $100 per barrel after breaching that mark last week for the first time since July.
Yields and oil were slightly lower on Wednesday, providing a boost to stocks. Elsewhere, the US dollar index rose 0.1%.
This would be the first hike under Fed Chairman Warsh
Investors and Federal Reserve watchers are now penciling in the first rate hike in three years on Wednesday.
Goldman Sachs, Piper Sandler and other banks that previously projected a hold have switched their call after last week’s hotter-than-expected inflation reports.
This would be the first rate hike under Fed Chairman Kevin Warsh, who was nominated by President Donald Trump. Trump has made no secret of his desire for not just slightly lower rates but dramatically lower rates.
Ironically, Trump’s own policies have helped create a situation where his handpicked Fed chair has no choice but to hike.
"There is no happy solution" based on rate hikes, Sen. Elizabeth Warren says
Sen. Elizabeth Warren, a fierce critic of Kevin Warsh, sounds like she almost feels bad for the Trump-appointed Federal Reserve chairman.
“Donald Trump’s economic policies have backed Kevin Warsh into a corner,” Warren told CNN.
The Massachusetts Democrat argued that Trump’s war with Iran and his volatile tariff policy have driven up inflation to the point that Warsh and his colleagues must consider action.
“He’s going to have to make a decision whether to bow down to Donald Trump and not do anything on interest rates, or to say to Wall Street that he is committed to bringing inflation under control,” Warren said.
Wall Street widely expects the Warsh-led Fed will deliver the first rate hike in three years on Wednesday.
“Either way…it’s the American people who are paying the price,” Warren said, noting that rate hikes will be an “economic disaster” for families by making it more expensive to pay off credit card debt and get a mortgage. “There is no happy solution at this moment based on interest rates.”
Warren has previously criticized Warsh as insufficiently independent from the White House, even describing the Fed chairman as Trump’s “sock puppet.”
But now Warsh could be on the verge of delivering the opposite of the deep rate cuts that Trump has been demanding.
Asked if a rate hike would change her perception of Warsh, Warren said: “It takes a long time, more than one action, to rebuild a reputation.”
Trump appointed Warsh to lower rates. He may end up with the opposite
President Donald Trump said his pick to replace former Federal Reserve Chair Jerome Powell would be someone who wants to lower interest rates. The man he ended up selecting, though, is about to give Trump exactly what he isn’t looking for.
“If I think somebody’s going to keep the rates where they are or whatever, I’m not going to put them in. I’m going to put somebody that wants to cut rates,” Trump told reporters in January, shortly before announcing he was nominating Kevin Warsh to helm the US central bank.
Trump has praised Warsh and said he trusts his handling of the economy. Instead, Trump has shifted the blame to 11 of Warsh’s colleagues who vote on interest rate decisions, calling them “political.”
September’s monetary policy meeting is Warsh’s third since he was confirmed in May, which means Trump may need to bite his tongue so as not to give the impression that he is unhappy with his decision. If he doesn’t, however, it could rattle markets, which are already under fire with Treasury yields spiking as well as oil.
Where consumers are spending their dollars
Wednesday’s retail sales report showed that part of the August increase reflects higher prices at the pump — since retail sales are adjusted for seasonal swings but not inflation.
However, even when excluding those purchases, retail sales were still up a robust 1.1% last month.
Sales at gas stations shot up 3.1% in August as the war in the Middle East intensified again, continuing to disrupting the global energy market.
Retail sales were up across most categories last month, except at home improvement retailers and department stores, which declined 0.2% and 0.8%, respectively. In addition to gas stations, sales were up the most for online retailers (2.6%), specialty shops (1.9%), electronics stores (1.6%) and food establishments (1.2%), which includes restaurants and bars.
Retail sales rebounded sharply in August in good news for the US economy
America’s economic backbone isn’t cracking just yet.
Retail sales rose 1.2% in August from the prior month, the Commerce Department said Wednesday, up sharply from July’s 0.5% decline. That was well above the 0.7% increase economists predicted in a poll by data firm FactSet.
Retail spending has trended lower in recent months, and the weak July reading raised questions whether the mighty US consumer might finally be buckling under the weight of higher inflation, mounting consumer debt and persistent economic uncertainty.
It turns out that’s not quite the case, at least for now. And that’s good news for the US economy, considering consumer spending accounts for about two-thirds of growth. Retail spending, which doesn’t including purchases on services, makes up one-third of overall spending.
Resilient consumer spending also shows the Federal Reserve has some room to raise rates to tame inflation, without risking pushing the US economy over the edge with a potential hike.
Stock futures rise ahead of Fed rate decision
Stock futures were higher Wednesday morning ahead of the Federal Reserve’s decision on interest rates, set to be announced at 2 p.m. ET.
S&P 500 futures rose 0.4%. Dow futures rose 160 points, or 0.3%. Futures tied to the Nasdaq 100 rose 0.6%.
Stocks are coming off a day in the red. The stock market has been in a mini slump, with the S&P 500 down about about 2.75% since hitting a record high on August 13.
The S&P 500 has dropped six out of the past seven trading sessions as rising oil prices and bond yields have weighed on the market.
Bond yields pulled back slightly on Wednesday after the 10-year yield on Tuesday closed around 5%, its highest level since 2007.
Yields have climbed amid a bevy of concerns from elevated energy prices and expectations for higher borrowing costs, as well as rising corporate debt issuance and unchecked government spending.
Oil prices were slightly lower Wednesday after Brent crude on Tuesday settled at $108.75 per barrel, its highest closing level since May 19.
