Key facts
- The Federal Reserve is expected to raise interest rates by 25 basis points on Wednesday.
- US August consumer inflation remained steady at 3.4%, above the Fed's 2% target.
- Market expectations for a Fed rate hike on Wednesday are over 85%.
- The Bank of Japan is predicted to raise its key rate after supportive data, including a significant jump in wages.
- Oil prices are above $100 a barrel, and the Middle East war is reigniting, contributing to global price pressures.
- The European Central Bank tightened policy for the second time since the outbreak of the Iran conflict.
The Federal Reserve and the Bank of Japan face critical decisions on interest rates as markets grapple with persistent inflation and growing government borrowing needs. Investors are closely watching the Fed's upcoming meeting, with many warning that standing pat on rates could further destabilize the bond market.
Many investors believe that if the Fed holds rates steady, it could fuel a bond selloff and push long-term rates higher, especially if the central bank's commitment to its 2% inflation target is questioned. This could lead investors to demand a larger term premium for holding longer-dated U.S. debt. Bill Campbell, portfolio manager at DoubleLine Capital, noted that a failure to hike could put more pressure on the back end of the curve.
Markets currently price in a roughly 76% chance of a quarter-point increase this week, following strong jobs data and a pickup in August consumer prices. If the Fed does tighten, it would be the first rate increase since July 2023. Investor attention has focused on the term premium in long-dated Treasuries due to inflation uncertainty and increasing Treasury issuance to fund fiscal deficits.
Loren Moran, fixed income portfolio manager at Wellington Management, argued that the recent bond selloff reflects more than just monetary policy, citing inflation above target, oil prices touching $100 a barrel, federal deficits near 6.5% of GDP, and strong economic growth. She believes the Fed needs to deliver clear action consistent with returning inflation to 2%, even if it means some economic pain, to anchor term premium and credibility.
However, not all investors agree. Russell Brownback, deputy chief investment officer for global fixed income at BlackRock, suggested that a rate hike would strain rate-sensitive sectors like housing without significantly slowing growth drivers. He dismissed concerns about the long end of the curve as overblown, noting that yields are only 50 basis points higher than at the start of the year despite accelerated growth.
Other investors, like Lon Erickson, portfolio manager at Thornburg Investment Management, see a 25-basis-point increase as reasonable, given that interest rate changes take time to impact the economy. He believes such a hike would not crush the economy given the overall healthy economic signals.