Fed Holds Rates Despite Inflation Angst as 30-Year Treasury Yield Hits 19-Year High

No clear plan despite emphasis on 2% inflation

Markets question Fed’s resolve to fight inflation

Odds of a September rate hike fall to 65%

The Federal Reserve left its benchmark interest rate unchanged on July 29. Some investors initially viewed the decision as a hawkish hold after three officials dissented in favor of another increase. Markets reacted differently. Concern spread that the Fed was taking a passive approach to inflation, sending long-term Treasury yields sharply higher and pushing all three major U.S. stock indexes lower. Confidence in a September rate increase, once seen as strong, has also begun to fade.

The Fed kept its policy rate at 3.50% to 3.75% at the Federal Open Market Committee’s July 28-29 meeting. That marked the fifth straight hold this year.

Three officials dissented. Cleveland Fed President Beth Hammack, Minneapolis Fed President Neel Kashkari and Dallas Fed President Lorie Logan favored a quarter-point increase. Markets had initially read the decision as a hawkish hold signaling further tightening ahead, but that view shifted after Fed Chair Kevin Warsh’s press conference. Warsh said the Fed had only one objective in fighting inflation: 2%. Investors, however, took the view that he failed to lay out a concrete plan. Asked why the Fed had not raised rates immediately if it would not tolerate inflation, Warsh replied that the central bank did not have a magic ability to bring inflation down quickly.

Warsh’s remarks also disappointed investors because they suggested rising market rates were already delivering some of the tightening effect. He said nominal and real yields had risen markedly across the Treasury curve in the 42 days since the previous meeting. That had offered some reassurance, he added.

Markets responded immediately. Some investors said the Fed had backed away from its fight against inflation. Others described Warsh as dovish despite the hawkish framing. The 30-year Treasury yield rose 0.14 percentage point during the session to 5.23%, the highest level since July 2007. The jump reflected concern that a slow Fed response could let inflation persist, keeping rates higher for longer and increasing the eventual cost of restoring price stability.

Jeffrey Gundlach, chief executive officer of DoubleLine Capital and often called the new bond king, said the Fed should have raised rates if it wanted to bring inflation down to 2%. The surge in yields was the market’s message to Warsh. As long-term rates climbed, all three major New York stock indexes extended their losses. Investors also worry that higher long-term borrowing costs could tighten funding conditions for U.S. households and companies, hurting the broader economy.

The odds of a September rate increase have also weakened. The implied probability of a hike in September fell to 65.2% from 76% before Warsh’s press conference.

Hwang Jung-soo in New York and Lee Sang-eun in Washington, correspondents, hjs@hankyung.com