Bond prices fell hard on Thursday as traders priced in a growing chance of a September rate hike. The ten-year Treasury yield rose 4.1 basis points to 4.663 percent, wiping out gains from earlier in the week. Investors are now betting that the Fed will tighten policy again after months of restraint.
The Fed kept rates unchanged at 3.5 to 3.75 percent for the fifth straight meeting, but the decision wasn't unanimous. President Beth Hammack of the Cleveland Fed, along with Minneapolis' Neel Kashkari and Dallas' Lorie Logan, wanted a quarter-point increase. Their dissent is sending a signal that some officials see inflation risks still lingering in the economy. Earlier this month, Lorie Logan argued that inflation has remained elevated for too long and is not on track to return to the Fed's 2% target. She believes that moderately higher interest rates would be appropriate under current conditions.
Oil prices are rising on Middle East tensions, adding to worries about inflation. The CME's FedWatch Tool shows traders are now 63.2 percent confident the Fed will raise rates in September. That number keeps climbing as officials show they're divided over the path forward. The Fed reiterated that inflation remains elevated due to higher energy prices linked to the Middle East conflict. Policymakers also reaffirmed their commitment to restoring price stability. Fed Chair Kevin Warsh said the U.S. economy remains resilient with a steady labor market. However, Warsh emphasized that inflation remains above the Fed's objective and reaffirmed the Fed's inflation goal of 2%.
Even a weak second-quarter GDP report failed to calm nerves. The Commerce Department said real GDP grew by 1.5 percent in the second quarter, below expectations of 2.3 percent. Government spending and investment slowed, though consumer demand picked up. Imports also rose more sharply, subtracting further from the growth calculation. Although inflation data showed encouraging progress in June, the improvement may prove temporary as renewed geopolitical tensions have pushed oil prices higher again. This may lead the Fed to hike rates ahead. Several policy makers who supported unchanged rates, cautioned that if inflation fails to resume its downward path, additional rate hikes could become necessary.