Fed Change of Guard Brings the Volcker Era, Market Bets on December Rate Hike

Kevin Warsh has officially taken the helm at the Federal Reserve, with bond investors expecting the new management to prioritize maintaining credibility against inflation rather than succumbing to President Trump's demands for interest rate cuts. Aided by the Iran war, which has triggered the largest inflation surge since 2023, traders currently believe that the Federal Reserve is almost certain to start raising interest rates before December. This forecast represents a fundamental reversal from the interest rate cut expectations three months ago. The volatility in the Middle East, the resilience of the US economy, and the boom in artificial intelligence investments driving up the stock market have collectively heightened the risk of inflation remaining above the 2% target for an extended period.

The U.S. bond market has already priced this in, with the two-year U.S. Treasury yield climbing to 4.14% on Friday, reaching a new high not seen in over a year and exceeding the upper limit of the Federal Reserve's benchmark interest rate by nearly 40 basis points; the 30-year yield once touched 5.2%, the highest level since 2007, before falling back to 5.06%. Most Federal Reserve officials are abandoning their accommodative stance. Governor Christopher Waller, who previously advocated for rate cuts to protect the labor market, said on Friday that the likelihood of the Federal Reserve's next move being a rate hike is now on par with a rate cut.

Despite Trump's repeated pressure to reduce borrowing costs, at Kevin Warsh's swearing-in ceremony last Friday, Trump publicly expressed his hope for Warsh to lead the Federal Reserve independently. Some investors have already begun adjusting their strategies. Capital Group's portfolio manager, Chitrang Purani, stated that as yields rise and rate hike expectations are digested, the attractiveness of short-term Treasury bonds increases, but the policy reaction mechanism of the new management will not substantially regress from the past, and the actual threshold for rate hikes remains relatively high. This week, the market will closely monitor speeches by Vice Chairman Philip Jefferson, New York Federal Reserve President John Williams, as well as the auction demand for two-year, five-year, and seven-year Treasury notes.