The Fed raised rates 25 basis points and framed it as removing "a dose of accommodation." The move takes back part of the "insurance cuts" made at the end of 2025, when the Fed cut 75 basis points. Fed officials no longer see financial conditions as clearly restrictive. A quarter-point does little to fix the energy supply shock, but it pushes the policy rate a bit more restrictive.
What Stood Out From the Meeting
The vote was unanimous, which was a surprise. There have been dissents in almost every meeting this year except June, so the whole committee shifting to a more hawkish stance was unexpected. The dot plot showed it too: at least 16 members now see at least one more hike this year.
The Fed chair repeated that the labor market is strong and stable and the economy is strengthening. Inflation stays high and has run above the 2% target for over five years. Acting now protected the chair's credibility after hawkish "tough talk" at Jackson Hole. The market had priced a 90% chance of a hike, which effectively forced the move. The prepared statement called jobs strong and the tone felt calm, not worried.
Yields and the Yield Curve
The two-year note sold off, dropped, then climbed back. The Fed controls the front end, and the two-year tracks the Fed funds rate. The two-year sits above 4.70%, about 100 basis points over the median Fed funds rate, so it has likely overshot too high. Rates rallied a little this morning, retracing part of the move.
The back end - the long-dated bonds like the 30-year - is driven by different forces the Fed cannot control: geopolitical events, fiscal worries, heavy debt issuance by AI hyperscalers, and rising sovereign yields across many countries. That is what pushes the long end up. The hike moved the front end closer to the two-year, but there is still ground to cover. Oil trades at $102, adding geopolitical uncertainty.
The October Problem
The next meeting is in October. Odds of a hike there sit under 50%, partly because it lands right before the midterm elections. Moving then would be politically hard; the Fed calls itself independent, but a hike would likely draw backlash from the administration. December looks far more likely - one path is priced near 54% and the next near 90%.
My read: the Fed will probably stay put in October and wait until December. One more hike is priced in, and there may be one to two more, possibly not until early next year rather than by year-end. Forward guidance is gone, so the reaction function is hard to predict. The chair stressed following the trend, not a single data point, and the inflation trend is the main thing to watch.
Reading the Mixed Data
The data has been whipsawing from supply shocks over two years - last year's tariffs and this year's energy shock. Retail sales looked good but do not adjust for inflation, so the real picture is weaker (a point Danielle DiMartino Booth made). Housing is tough with 7% mortgage rates. Manufacturing is soft: the New York (Empire) survey was terrible, and the Philly index fell 10 points from last month even though it beat estimates. Jobless claims came in a little better and jobs are holding up.
Core CPI year-over-year was the lowest since March 2021, but the month-over-month figure ticked higher. The question is whether the trend keeps pushing year-over-year down toward the 2% target. Rather than trade each print bullish or bearish, focus on the trend, with inflation as the priority.
How to Position
Be cautious on duration, since rates stay volatile. Treasury option income is a good way to harvest some of that volatility. Yield is your friend now - higher yields give a yield cushion in a portfolio, so fixed income still offers attractive opportunities. Follow the trends, pick which pockets of data to trust, and find the best spots to capture these higher yields.
