Another fine mess for the Fed

My Wednesday deadline means I must always file my column just before important economic and financial announcements in the US, like the Federal Reserve’s interest-rate decision every six weeks — just like today. That can be pretty frustrating once you get into the habit of following global bond yields to understand rapidly shifting international economic trends, especially what happens further down the financial plumbing, where emerging and frontier markets like Pakistan are often left struggling with consequences they had no part in creating. So, at the time of writing, the Fed has not spoken. Markets overwhelmingly expect it to raise rates by 25 basis points, its first increase since 2023, taking the benchmark range to 3. 75-4. 00pc. But perhaps the more interesting question is what exactly Fed Chair Kevin Warsh will be tightening against: inflation, oil, an economy still running hot, a bond market increasingly uncomfortable with America’s fiscal trajectory, or the president who appointed him and keeps demanding precisely the opposite? Donald Trump wants lower interest rates. The bond market, meanwhile, has pushed the 10-year Treasury yield through 5 percent, briefly taking it to a 19-year high of 5. 041 percent. Warsh spent Jackson Hole sounding sufficiently hawkish to convince markets that persistent inflation required action. And Treasury Secretary Scott Bessent has now acknowledged that America’s fiscal deficit is among the forces driving yields higher, even as he defends Treasury buybacks intended to contain the rise in borrowing costs. Quite a lot, then, seems to be going wrong with the cheaper-money plan. There is also the small matter of the Iran war. Oil remains above $100, Brent is up roughly 19 percent since the beginning of September, and renewed disruption across the Middle East is feeding directly into inflation expectations and bond yields. Saudi Arabia suspended loading at its Yanbu port this week, while the Strait of Hormuz remains severely disrupted. Six months after Washington stumbled into a war that was supposed to reorder the region rather more neatly, its economic consequences are now turning up everywhere from petrol pumps to Treasury screens. How much easier would Warsh’s decision be without that particular contribution to the inflation problem? The contradiction is becoming difficult to miss. Trump wants the Fed to cut rates aggressively and has even spoken of America having the lowest borrowing costs in the world. Yet his administration is fighting a war that has helped drive energy prices sharply higher, while fiscal policy continues to give bond investors reasons to demand greater compensation for lending to Washington. Now comes the extraordinary proposal to send $5, 000 cheques to Americans if Republicans retain Congress — a plan that could cost at least $1. 2 trillion and for which no clear funding source exists. For a Fed chair who has spent years arguing that excessive money creation helped cause the post-pandemic inflation surge, that must make for interesting conversation at the White House. The immediate market question is whether today’s expected hike would be one-and-done or the beginning of another tightening cycle. Futures have been pricing further increases over the coming year, potentially taking the policy rate towards 4. 6 percent. Yet the longer end of the Treasury market has already done considerable tightening of its own. The 10-year yield has risen roughly 100 basis points over the past year, before the Fed has even begun the cycle markets now expect. History offers uncomfortable possibilities. Across the last 12 proper US tightening cycles studied by Deutsche Bank, the 10-year Treasury yield rose by an average of roughly 114 basis points during the year after the first hike. Another study covering seven cycles since 1986-87 produces almost the same result. Of course, this cycle begins with the 10-year already around 5 percent, and inflation-adjusted Treasury yields are at their highest since 2008, which could eventually attract enough buyers to restrain the move. But what if they do not? Debt and deficits have not disappeared; neither has the extraordinary capital demand generated by the AI investment boom. Energy-driven inflation is back with considerable force, and questions about policy credibility are becoming harder to separate from the bond market’s judgment of Washington. A 6 percent 10-year Treasury yield may still sound extreme, but perhaps 5 percent sounded rather dramatic not very long ago too. That matters because the Treasury yield is hardly an American curiosity. It is the benchmark against which trillions of dollars of mortgages, corporate bonds and loans are priced around the world. When it rises, the global cost of capital rises with it. Equities must compete with increasingly attractive government bonds, companies refinance at higher rates, dollars become more expensive and capital becomes less forgiving of economies carrying weaker balance sheets. Which brings the story, inevitably, to Pakistan. Pakistan has no vote at the Federal Reserve and no influence over the Strait of Hormuz, yet it can be hit by both. Oil above $100 threatens the import bill, the rupee and domestic inflation just as price pressures are already rebuilding. Higher US yields raise the hurdle rate for capital across emerging and frontier markets, while tighter global financial conditions can make external refinancing more expensive precisely when vulnerable economies need room rather than another squeeze. And this is where today’s Fed decision becomes more than another quarter-point adjustment in Washington. If Warsh hikes, markets will immediately ask how many more increases follow. If he holds, they may ask whether political pressure has begun contaminating the Fed’s inflation response. Either way, the bond market will deliver its own verdict. By the time this column appears, we will know what Warsh decided. The more interesting question may be whether the White House likes the answer. Copyright Business Recorder, 2026

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