Bond traders have sharply increased their expectations that the US Federal Reserve could raise interest rates at its July meeting, as investors await fresh inflation figures and congressional testimony from Fed Chairman Kevin Warsh.
Market pricing now indicates roughly a 50 per cent probability of a quarter-percentage-point increase later this month. That is a substantial rise from less than 10 per cent previously, reflecting growing concern that interest rates may need to remain higher—or rise further—to bring inflation back towards the Fed’s 2 per cent target.
The change in expectations has also been reflected in the US Treasury market. The yield on the two-year Treasury note, which is particularly sensitive to changes in monetary policy, remained above 4.25 per cent on Tuesday. It has moved increasingly above the Fed’s current policy rate as investors prepare for the possibility of tighter monetary conditions.
Columbia Threadneedle portfolio manager Ed Al-Hussainy said a July rate increase had become a realistic possibility and judged an increase to be more likely than not. He argued that inflation could struggle to return to the Fed’s target without further policy action, particularly after the Fed’s preferred inflation measure remained at 4.1 per cent in May.
Rate-hike expectations strengthened after Fed Governor Christopher Waller said policymakers should consider increasing borrowing costs in the near term if the latest data show another strong rise in underlying inflation. Waller’s comments drew attention because he had previously been regarded as one of the more cautious or dovish members of the central bank.
Economists surveyed by Bloomberg expected June’s consumer price index report to show some moderation. Overall prices were forecast to decline by 0.1 per cent from May, lowering annual inflation to 3.8 per cent from 4.2 per cent. Core prices, which exclude volatile food and energy costs, were expected to rise by 0.2 per cent over the month and 2.8 per cent from a year earlier.
However, even a softer inflation report may not fully ease pressure in the bond market. Investors remain concerned that renewed increases in oil prices, linked to escalating conflict involving the United States and Iran, could push transport, manufacturing and consumer costs higher and make inflation more difficult to control.
Attention is also focused on Warsh’s testimony before Congress on July 14 and 15 as part of the Fed’s semi-annual monetary policy report. Warsh, who took office in May, has generally avoided providing firm guidance about future interest-rate decisions, leaving financial markets uncertain about how the central bank will respond to incoming data.
Short-term interest-rate markets are now fully pricing in at least one Fed increase before the end of 2026 and another by the middle of 2027. Al-Hussainy believes this may still underestimate the scale of future tightening and has suggested the Fed could eventually reverse all three quarter-point rate cuts delivered during the final months of 2025, when labour-market conditions were weakening.
Demand for contracts linked to future Fed decisions has risen strongly. Open interest in August federal funds futures increased by about 23 per cent during July, indicating that more traders are actively positioning for possible monetary-policy changes.
Treasury prices have already come under pressure. Two-year yields have climbed by around 10 basis points in July, while 10-year yields have gained approximately 15 basis points. Those moves have erased the US government bond market’s earlier gains for 2026, according to the Bloomberg Treasury index.
BMO Capital Markets rates strategist Ian Lyngen said investors were concentrating on the Federal Open Market Committee meeting scheduled for July 29, which could become Warsh’s first meeting to deliver a rate increase as Fed chairman. Lyngen expects softer inflation data and Warsh’s testimony could reduce confidence in an immediate increase, but the chairman’s reluctance to provide clear forward guidance may prevent expectations from falling significantly.
As a result, markets may continue assigning a meaningful probability to a July increase even if inflation comes in below forecasts. Analysts have also warned that the Fed could surprise investors with a hike before such a decision is fully reflected in market prices, particularly if policymakers believe inflation is becoming entrenched or energy-related price pressures are intensifying.
