Federal Reserve Chairman Kevin Warsh's recent testimony before Congress has caused uncertainty among bond traders regarding the central bank's next interest rate move. While June saw the first monthly drop in US consumer prices since 2020, and annual inflation slowed to 3.5% from 4.2% in May, Warsh's comments did not definitively signal a rate hold, despite easing inflation giving him more room to maintain the current policy rate of 3.5% to 3.75%. Money markets are currently pricing in a 31% chance of a rate hike this month, and a 74% chance of at least a quarter-point hike in September, according to CME's FedWatch tool. Traders had previously unwound bets on a rate hike after the downside surprise in the US CPI print last week, with the probability of a July hike dropping as low as 10% before recovering to 26% by Tuesday's close.
Warsh, who became Federal Reserve Chairman at the end of May, affirmed the central bank's commitment to a 2% inflation goal and emphasized the importance of bringing down the inflation rate. His comments were consistent with the Fed's June 17 statement which noted inflation has been running above target. However, the economic outlook remains exposed to fresh shocks, such as geopolitical risks potentially boosting oil prices, which could complicate the Fed's efforts to achieve price stability. For instance, crude oil and gas prices have recently spiked due to renewed military action in Iran, with average gas prices rising to about $4 a gallon.
Treasury yields have seen some fluctuations as investors assess these factors. The yield on the 10-year U.S. Treasury note was up 2 basis points at 4.648%, while the 2-year Treasury note yield, which closely tracks short-term Federal Reserve interest rate policy, rose more than 3 basis points to 4.298%. The longer-dated 30-year Treasury bond yield was higher by 1 basis point at 5.141%. The current market sentiment reflects a divided outlook, with eight of the eighteen bank presidents and board of governors projecting that rates will remain steady this year, while another nine project higher rates.
