Persistent increases in U.S. Treasury yields have fundamentally altered market expectations for the timing of the Federal Reserve's next rate hike cycle. Data from prediction platform Kalshi shows traders assign a 63% probability to a Fed rate hike before July 2027, with a 43% chance of a hike occurring this year. Traders on another platform, Polymarket, see a 35% probability of a hike in 2026. Market turbulence has shattered hopes for rate cuts, reviving the specter of monetary tightening.
While former U.S. President Donald Trump's initial intent in nominating a new Fed Chair was to push for rate cuts, his nominee, Kevin Warsh, may now initiate the Fed's first rate hike cycle since 2023. Influenced by soaring Treasury yields, persistent inflation, a stalemate in Iran-related tensions, and oil prices showing no clear signs of retreat, market expectations for a Fed rate hike have surged dramatically over the past 24 hours. Previously, traders saw only a 50% chance of a hike in the first half of 2027. The probability of a Fed hike before July 2027 has increased significantly.
The rise in rate hike expectations coincides with incoming Fed Chair Kevin Warsh's scheduled swearing-in this Friday, succeeding Jerome Powell. Trump nominated Warsh at the end of January, having previously criticized Powell for not cutting rates quickly enough. However, the probability of rate cuts has been declining ever since.
A resilient labor market and resurgent inflation have led many economists to scale back their rate cut forecasts. Several members of the Federal Open Market Committee explicitly stated in their last meeting that they had no intention of signaling future rate cuts. The ongoing rise in U.S. Treasury yields has prompted investors to reassess the outlook. On Tuesday, the yield on the 30-year U.S. Treasury note climbed to its highest level since 2007.
Ed Yardeni, Chief Investment Strategist at Yardeni Research, who coined the term "bond vigilantes," suggested on Monday that the bond market might exert more influence over monetary policy than the incoming Chair Warsh. He stated, "Who's really dictating the direction of monetary policy? The answer, undoubtedly, is the bond vigilantes."
In contrast, Chris Senyek, Chief Investment Strategist at Wolfe Research, presented a different view in a Tuesday report. He argued that the bond market turmoil might force a resolution in the Middle East situation, thereby alleviating upward pressure on inflation. He stated, "We believe the U.S. Treasury market has been signaling high inflation, and this week's moves were the straw that broke the camel's back. Our judgment is that bond vigilantes might push yields higher in an attempt to force the Trump administration to resolve the Iran issue swiftly."
Notably, as the new Fed Chair prepares to take office, Trump's insistence on rate cuts has softened. According to reports, Trump stated in a recent interview that rising inflation linked to the Iran conflict complicates the prospect of U.S. rate cuts. A full assessment of inflation data can only be made once the Middle East conflict stabilizes. "You can't really see the data clearly until the war is over," Trump said, referring to the impact of oil price increases related to the Iran conflict.
Warsh's first policy meeting as Chair is scheduled for mid-June, where he will face a growing "hawkish" contingent. Chicago Fed President Austan Goolsbee stated this week that the U.S. faces excessively high inflation, which must be Warsh's primary consideration as Chair. Yardeni of Yardeni Research also believes that, given the current market environment is "no longer" suitable for accommodative policy, the Fed should remove its easing bias at the June meeting. He further expects the Fed to hold rates steady in June and shift towards a tightening policy stance. Currently, interest rate futures markets assign almost zero probability to a change in the Fed's policy rate in June.
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