Strong market signals push Fed toward rate hike

The Federal Reserve's decision day has arrived.

All attention today centres on the FOMC meeting outcome. While the central bank technically has two options, market conditions make a hold look increasingly unworkable.

Traders now assign over a 90% probability to a 25-basis-point rate increase, while 10-year yields approach 5% for the first time since 2007. That pairing highlights the pressure ahead of the decision.

Investors are concerned not only about persistent inflation but also about the Fed's willingness to address it.

August inflation figures confirmed that price pressures are stubborn. Oil has risen above $100, and long-dated Treasury yields have climbed to levels unseen in almost 20 years.

If the Fed overlooks these signals, investors might see the move as hesitancy rather than patience.

That perception carries particular weight for long-term bonds.

A hold might initially push two-year yields down, but ten- and thirty-year yields could react very differently.

Market participants would likely demand greater compensation for inflation risk and policy credibility, causing the term premium to increase.

That scenario would produce an uncomfortable result: no rate hike yet higher long-term borrowing costs.

Treasury buybacks would not solve that issue. Following the August CPI release, the probability of a September rate increase jumped. The bond market has effectively called for orthodox monetary policy: tighten if inflation proves persistent.

The Fed has therefore painted itself into a tricky position.

Raising rates risks growth and market stability. But with expectations so heavily skewed toward a hike, standing pat could send a more damaging signal.

Any long-end yield increase would not be small or gradual; moves could be sharp and even disorderly.

The risk extends beyond a 5 or 10 basis point rise. BofA warns that 30-year yields could quickly climb to 5.75% if the Fed holds rates steady.

That underscores the severity of the Fed's position heading into today's decision.