Last week’s CPI data, which surprised markets with a bigger-than-expected increase in prices, has increased the conviction of investors that the Fed needs to hike rates to maintain credibility.  Despite Federal Reserve Chairman Warsh’s recent speech at the Jackson Hole symposium, markets are continuing to seek clues regarding the Fed’s plan to bring inflation back to its 2% target.  Warsh’s comments were received by the markets as hawkish and have prompted increased bets on a September rate hike.  This morning, Fed funds futures are now pricing in the likelihood of a Fed rate hike of 25bp at over 90% for the Fed’s meeting later this week.  Furthermore, renewed aggression in Iran is placing upward pressure on oil prices with ICE Brent Futures now approaching $110 per barrel, leading to further speculation about inflation and pushing 10-year Treasury yields to over 5%.

Last week, the capital markets were focused on the Federal Reserve Bank of Kansas City’s annual economic symposium in Jackson Hole, Wyoming.  The markets were seeking clarity on the Fed’s economic outlook and looking for clues about its strategy to bring inflation back to target.  Although Chairman Warsh did not reveal much, he did reiterate that curbing inflation is the central bank’s top priority and that inflation is not slowing meaningfully.  Chairman Warsh also described interest rates as the Fed’s “predominant tool” for controlling inflation.  These comments were received by the markets as hawkish and have prompted increased bets on a September rate hike.  This morning, Fed funds futures are now pricing in the likelihood of a Fed rate hike of 25bp at over 90% by the October 27-28 meeting.  To compound matters, renewed aggression in Iran is placing upward pressure on oil prices leading to further speculation about inflation.

Last Wednesday, the Treasury Department announced that it would increase buybacks of long-term bonds through its extended debt repurchase program.  The announcement was made after long-term Treasury yields hit the highest levels we have seen on nearly 20-years.  The move initially prompted a Treasury market rally, however Treasuries later sold-off as the market questioned the potential impact of increasing buyback operations from $2 billion to at least $4 billion in the $31.5 trillion Treasury market.  Furthermore, investors remain cautious amid stubbornly high inflation, mounting federal debt, and a new Federal Reserve chairman inclined to remain quiet.  Fed funds futures are now pricing in the likelihood of a Fed rate hike of 25bp at over 100% by the December 8-9 meeting; which, as of earlier this month, was thought to occur as soon as October.  Furthermore, this week bond traders will be paying attention to the GDP and personal consumption expenditures price index on Wednesday and Kevin Warsh’s first Jackson Hole Economic Policy Summit as Fed Chairman.

The yield on 30-year Treasuries hit the highest level since 2007 today as investors struggle with inflationary pressures amid inflation that has exceeded the Fed’s target 2% rate for the past five-years.  Although both CPI and PPI prints from last week were better than economists had forecast, surging government spending amid stubborn inflation and faint prospects of peace in Iran have markets nervous.  In addition, energy prices continue to creep-up, with restricted oil traffic through the Strait of Hormuz.  ICE Brent Futures are now back in the low $90’s.  Furthermore, the last Fed meeting has left many market participants unconvinced of the Fed’s commitment to fighting inflation.  The impression of a stable labor market combined with elevated energy prices continues to sustain a narrative for Fed rate hikes later this year.  Fed funds futures are now pricing in the likelihood of a Fed rate hike of 25bp at 96% by the December 8-9 meeting; which, as of earlier this month, was thought to occur as soon as October.