Tim Murray, a capital markets strategist in the multi-asset division at T. Rowe Price, noted that the Federal Reserve shifted its monetary policy stance on September 16, raising the target rate range by a quarter point for the first time since 2023. However, the truly noteworthy development is not the 25 basis point hike itself, but the fact that the rate-cutting cycle has come to an end. The key question now is: how much will the Fed ultimately need to raise rates.
Currently, investors expect this rate-hiking cycle to be relatively mild. As of September 23, interest rate futures markets reflected expectations that the Fed could raise rates nearly two more times before year-end, each by a quarter point; and through the end of 2027, the market expects a cumulative total of slightly more than four hikes. In other words, the market appears to view this hike as closer to a mid-cycle policy adjustment rather than the full launch of a new rate-hiking cycle.
Murray noted that while this expectation could certainly materialize, historical experience suggests investors should not be too certain. The modern operating model of Fed monetary policy began in February 1994, when the Fed started announcing decisions on the same day it adjusted rates. Since then, the Fed has gone through six rate-hiking cycles, of which only one was truly a mid-cycle policy adjustment. In the other five rate-hiking cycles, the federal funds rate ultimately rose by at least 175 basis points from the start of the cycle.
The only exception was 1997, when the Fed raised rates just once before switching to cuts, but that policy pivot was only temporary. The Fed subsequently cut rates three times, yet launched another rate-hiking cycle in 1999, which only ended about a year later when the tech stock bubble burst.
Although current interest rate futures market expectations may prove accurate, historical experience shows that once the Fed begins raising rates, the ultimate magnitude of hikes often far exceeds the market's initial expectations.
Murray further noted, however, that what matters is that the impact of Fed monetary policy on long-term U.S. Treasury yields has gradually diminished. Over the two years through September 23, 2026, the U.S. 10-year Treasury yield rose from about 3.73% to 5.1%, a cumulative increase of roughly 137 basis points. Of that, only about 72 basis points of the increase can be attributed to the market raising its expectations for future Fed rate levels, while the remainder reflects a rise in term premium.
Term premium refers to the extra return compensation investors demand for holding longer-term bonds. Factors pushing up term premium include: increased geopolitical uncertainty, persistent inflation concerns, heavy issuance of U.S. Treasuries, and market expectations of rising global capital expenditure. Even if the Fed's ultimate rate hikes are relatively mild, these pressures are unlikely to dissipate as a result.
Therefore, even if the market's expectations for the Fed's rate path prove accurate, long-term U.S. Treasury yields could still continue to edge higher.
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