Inflation runs slightly hot before the Fed decides
The August Consumer Price Index, published on the morning of Sept. 11, was the final major data point before the Federal Open Market Committee meets on Sept. 15-16 to set interest rates. The reading came in a touch warmer than economists had projected. Seasonally adjusted, the headline CPI advanced 0.4% for the month, putting the year-over-year figure at 3.4% — both matching consensus estimates. Core CPI, which excludes volatile food and energy costs, rose 0.3% in August, one-tenth of a point above expectations, while the annual core rate held at 2.4%, in line with forecasts.[S1]
The market's reaction was immediate. According to CME Group's FedWatch tool, the probability of a quarter-point increase at the upcoming FOMC meeting climbed from roughly 72.4% on Sept. 10 to nearly 87% by 12:26 p.m. ET on Sept. 11. Rate hikes are typically seen as a drag on equities, yet the Dow Jones Industrial Average had surged 527 points by that time, and the other major indexes were also in positive territory.[S1]
Why bond yields pushed the Fed toward a hike
Not long ago, the FOMC appeared unlikely to raise rates this year. Inflation had shown signs of cooling, and it might have eased further had the Iran war ended or tensions between the sides diminished. There was also a belief that the FOMC and Fed Chair Kevin Warsh would prefer not to tighten just weeks before the midterm elections. But the bond market has been a persistent problem for the Fed. The 10-year Treasury yield stood near 4.95%, while the 30-year bond yielded about 5.34%. Elevated yields raise borrowing costs for consumers and businesses and make new U.S. government debt more expensive — a serious concern with total U.S. debt above $40 trillion and interest payments already consuming 15% of the federal budget.[S1]
Treasury Secretary Scott Bessent has made several recent moves aimed at containing bond yields. At the FOMC's previous meeting, three of the twelve voting members dissented in favor of a quarter-point hike. Since then, additional FOMC members have said publicly they would back a September increase if inflation fails to show signs of slowing.[S1]
The silver lining lifting stocks
Bond market watchers have been paying close attention. Long-dated yields had already been rising amid concerns about inflation and government debt, and they reacted when the FOMC chose not to lift rates at its prior gathering. Fixed-income investors seemed annoyed that officials discussed containing inflation but stopped short of acting. Now, with a September increase viewed as very probable, traders may think an actual move would bring inflation expectations down and, in turn, pull long-term yields lower. At the time of writing, the 10-year Treasury yield had ticked higher on the day, while the 30-year yield was marginally lower.[S1]
Nothing ensures the FOMC will actually act at the next meeting; the Fed has communicated less openly since Warsh assumed leadership. Even so, the market mostly anticipates a move and assigns about a 48% probability to another quarter-point increase at the FOMC's December gathering, its last of the year. The main indexes had declined on each of the four sessions before Sept. 11, so the hike may already have been reflected in prices. Yet with the 10-year yield having recently topped 5%, the bond market appeared to be indicating that the Fed needed to tackle inflation. Since most investors now expect a hike, the bond market may feel more confident the Fed will act, which might explain the modest retreat in yields. Only time will reveal the outcome, and the September FOMC meeting looks set to be lively.[S1]
