Will the Fed Raise Rates in September? Bond Market Still Betting on 50-50 as It Eyes Two Key Data Points

Despite moderate U.S. inflation data, traders are maintaining hedges against a potential Fed rate hike in September, with market pricing showing a 50% probability of a hike at the next meeting.

The U.S. Consumer Price Index (CPI) met expectations, driving U.S. Treasury bonds higher on Wednesday (12th). The 2-year Treasury yield, most sensitive to Fed policy changes, fell 3 basis points to 4.18%; the benchmark 10-year Treasury yield also dropped 3 basis points to 4.65%. Markets are also awaiting a $420 billion 10-year Treasury auction later that day.

The interest rate swap market shows that after the economic data release, traders reduced the probability of a rate hike in October from around 75% the previous day to around 60%, while the market has fully priced in expectations that the Fed will take its next action in December.

Steve Ryder, senior fixed income portfolio manager at Aviva Investors, said: "This data should allow the market to continue to keep the possibility of a September rate hike on the table, but it doesn't create an urgency for the Fed to act immediately."

He noted that policymakers may place greater emphasis on the next CPI and employment market reports before deciding whether further tightening is needed later this year.

According to U.S. Bureau of Labor Statistics (BLS) data, the core CPI, excluding volatile food and energy items, rose 0.2% month-over-month in July; the annual rate was 2.5%, the slowest pace since March 2021.

Before this inflation data was released, last week's July employment market data was below expectations. As the Fed's next interest rate decision meeting is not until September, market focus will shift to the next round of August inflation and employment reports.

During this period, bond investors will also closely monitor the annual global central bank symposium held in Jackson Hole, Wyoming.

Christopher Hodge, chief economist for the Americas at Natixis, said that future Fed meetings must include the possibility of a surprise rate hike, but the firm still believes that with inflation slowing and gradually returning to target, consumer spending cooling, and the labor market outlook becoming more fragile, the Fed may ultimately narrowly avoid a rate hike.