(Bloomberg) — Bond traders are pricing in a Federal Reserve interest-rate hike Wednesday with a level of conviction that has proven right for decades.
Interest-rate swaps tied to Fed meeting dates show traders see about a 94% chance that Fed Chairman Kevin Warsh and his colleagues will lift the benchmark policy rate by a quarter point from the current 3.5%-3.75% range. That equates to roughly 23 basis points of tightening priced in.
Whenever expectations of a hike have been that high, the Fed has invariably delivered one, according to Bloomberg-compiled data going back to 2008. Using fed fund futures data, Deutsche Bank AG strategists concluded that forgoing a hike Wednesday would mark the “biggest dovish surprise” at a scheduled policy meeting since 1994, when the central bank began announcing rate decisions at the conclusion of its meetings.
Of course, this decision has an unusual backdrop, given that President Donald Trump, who picked Warsh, repeatedly pressed the central bank to slash rates under former chief Jerome Powell.
“The market is not prepared for a hold or dovish hike,” said Caesar Maasry, head of investment research at Lunate.
The Fed has historically sought to avoid surprising markets, particularly when raising rates, given the risk of triggering volatility. But uncertainty around its decisions has increased since Warsh took the helm in May and abandoned the Fed’s long-held practice of signaling policy moves well in advance.
That was evident in late July, when traders saw a 38% chance of a rate increase the day of the decision, before the Fed ultimately stayed on hold. At the July gathering, Warsh’s ambiguity on his plan to fight inflation helped trigger a selloff in long-term bonds. This time, however, the level of confidence is much higher.
Expectations for a September hike began building after Warsh said last month that the Fed would ensure that inflation will cool “at sufficient speed.”
By Friday, traders all but locked in an increase after consumer-price data showed inflation — which has remained above the Fed’s target for more than five years — was showing little sign of cooling. After the report, a slew of major Wall Street firms changed their September calls from a hold to a quarter-point increase.
Still, some traders are guarding against a surprise. Demand surged Tuesday for short-term interest-rate options that would pay off if the Fed unexpectedly holds rates steady.
The stakes are high for the bond market as 10-year Treasury yields rose to the highest since 2007 on Tuesday, with surging oil prices fueling inflation concerns.
“Tomorrow’s Fed will be the most consequential one we’ve had in some time,” said Alex Cohen, a foreign-exchange strategist at Bank of America. “With a hike about 90% priced, it would be nearly unprecedented for them to hold at this stage.”
–With assistance from Greg Ritchie and Michael Ball.
(Update with Deutsche Bank strategist comment in third paragraph.)
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