Will the Fed Stop Hiking Rates This Year? Oil Prices Plunge, Rate Hike Bets Fade as US Bonds Rally Across the Board

Oil prices plunged more than 3% on Thursday, adding downward pressure on U.S. Treasury yields and inflation expectations. Since late February, when the U.S. attacked Iran and triggered supply disruptions, oil has been a key driver of bond market sentiment. As traders reassess signals from the Middle East conflict, falling energy prices are reinforcing optimism that U.S. inflation may have peaked.

Treasury yields declined across the curve, with the 30-year yield dropping 8 basis points ahead of a new bond auction. Despite the drop, this 30-year issuance could still record the highest yield at auction since 2001 for its maturity, potentially attracting long-term investors due to higher yields and a steeper yield curve.

Market expectations for a Fed rate hike began fading after last week’s weaker-than-expected July jobs report. The U.S. nonfarm payrolls unexpectedly declined in July, compounded by downward revisions to prior months, leading traders to scale back bets that Fed Chair Kevin Warsh and other officials would need to raise borrowing costs further.

This view was reinforced by this week’s price data. The July Producer Price Index (PPI), released Thursday, was flat month-over-month—below expectations—with the annual rate easing from June’s 5.5% to 4.7%. The day before, the Consumer Price Index (CPI) showed cooling for the second consecutive month.

Colin Finlayson, Investment Manager at Aegon Asset Management, noted that markets had spent recent weeks debating Warsh’s commitment to fighting inflation and whether further Fed tightening was necessary. However, this week’s inflation data has cooled those debates. Bond valuations continue to support the fixed-income market.

Short-term interest rate futures rose, reflecting traders’ reduced expectations for future Fed hikes. There is clear demand in the interest rate derivatives market, with investors betting the Fed will tighten less than previously anticipated. Contracts expiring in March next year are particularly active.

The market-implied probability of a rate hike at the Fed’s September meeting has now fallen below 40%. For December contracts, earlier this week the market fully priced in one 25-basis-point hike by year-end; now, only about 23 basis points of tightening are priced in—less than a full hike. "Given current data, it seems outdated for the market to keep talking about rate hikes," Finlayson said.

Warsh’s speech at the Jackson Hole central bankers’ symposium will be the next key test.

Fed officials still project one rate hike this year in their latest quarterly forecasts. At last month’s meeting, three officials—including Cleveland Fed President Beth Hammack—voted dissenting, advocating for a 25-basis-point hike.

Hammack reiterated Thursday, during an event in Ohio, that she still sees a case for hiking rates, given inflation has remained above the Fed’s 2% target since 2021. The Fed’s preferred inflation gauge, the PCE price index, rose 3.6% year-over-year in June. The July Personal Consumption Expenditures (PCE) price index is scheduled for release on August 26.

John Briggs, Head of U.S. Rates Strategy at Natixis North America, warned that recent bond market gains may have already priced in a benign PCE print, making further upside challenging. Warsh is set to speak at the Jackson Hole global central banking symposium at the end of August. To maintain credibility on inflation control, he might adopt a hawkish tone even if the policy direction remains unchanged.

As a result, Natixis is taking a cautious stance over the coming weeks, favoring positioning in the middle of the yield curve and trades that bet on a steepening curve. Gennadiy Goldberg, Head of U.S. Rates Strategy at TD Securities, believes higher yields could help attract demand for the 30-year bond auction, but stresses that the next economic data and geopolitical developments remain critical. Investors are likely to continue short-term, opportunistic trading.