Fed's Williams sees another rate hike as Treasury rout deepens

New York Federal Reserve President John Williams said Thursday that investors are right to expect another interest-rate increase before year-end, a signal that arrived as a selloff in US government debt pushed long-term borrowing costs to their highest levels in more than two decades.

Speaking in London at a conference hosted by the National Institute of Economic and Social Research, Williams said market forecasts showed investors believed "another rate hike may be appropriate by the end of the year."

The comment from Williams, who's also vice chair of the Federal Open Market Committee and a permanent voter on rate policy, stopped just shy of a commitment. Williams said the Fed is done with explicit forward guidance and that policymakers will assess incoming data before deciding on future moves. He also told the audience the US economy was displaying "remarkable resilience," according to Reuters.

On Thursday, CME Group's FedWatch tool put the probability of an October rate hike from the Fed at 77.5%. The central bank delivered the Fed's first rate increase since July 2023 last week, lifting its policy rate to a range of 3.75% to 4% in an emphatic and unanimous 12-0 vote.

Two-decade highs in long-dated Treasury yields

The bond market has been pricing in a hawkish path for days. The 30-year Treasury yield touched roughly 5.44% on Thursday, its highest since 2004, before settling near 5.40%. The benchmark 10-year yield, which anchors mortgage rates, eased to 5.10% after reaching its highest level since July 2007 earlier in the session, while the two-year note held close to a 2023 high.

Thursday's moves extended a sharp Wednesday selloff. The 10-year yield posted its biggest one-day rise since April last year as traders digested stronger-than-expected economic data, hawkish Fed commentary and high oil prices. S&P Global's flash readings on manufacturing and services came in at their highest in more than four years, raising concern that sticky inflation could push the Fed to act in October.

Read more: Warsh-led Fed faces a rate dilemma Trump himself helped create

Mike Sanders, head of fixed income at Madison Investments, pointed to a convergence of fiscal, economic, geopolitical and supply-side inflation pressures, telling CNBC the rise in yields "can no longer be attributed simply to concerns over the deficit."

The pressure is spreading beyond US borders. Japan's 10-year yield hit its highest since 1996 on Thursday, as per Reuters reporting, while Germany's 10-year Bund briefly topped 3.5% earlier in September, a 17-year high. Germany's finance agency expects federal borrowing to reach a record €525.5 billion in 2026.

Washington, for its part, has taken efforts to keep the rout contained. Treasury Secretary Scott Bessent has expanded buybacks of 20- and 30-year debt and intervened to buy yen so Tokyo would not need to sell Treasuries, Reuters reported, though yields have kept climbing.

What does the bond rout mean for investors?

So far, the damage to risk assets has been limited. Nominal US growth ran at around 8% in the second quarter, corporate profits remain strong and AI-driven spending continues, according to Reuters. The Nasdaq Composite closed at a record on Tuesday.

That calm may be tested. Analysts cited by Reuters warned that borrowing costs could be nearing a level where markets hit turbulence, a tipping point that would echo the global bond selloff that strained fixed-income portfolios last month.

Read more: Global bond selloff drives borrowing costs to multi-decade highs

"Treasuries are competing with the rest of the market to be purchased and so you know, the question is, how much higher could it go?," said Hank Calenti, global markets strategist at SMBC EMEA.

Higher borrowing costs pinch household budgets

The squeeze is spreading to consumers. Short-term consumer borrowing rates generally follow the Fed's benchmark, while longer-term loans are tied to the 10-year Treasury yield. The prime rate, the baseline for adjustable-rate credit, stood at 7% after last week's quarter-point increase.

Thirty-year mortgage rates are now around 7%, near a two-year high and about a percentage point above where they stood before the Iran war, Reuters reported.

"Obviously the higher things go, the worse everything looks, and the more expensive US mortgages will be, for example, and the bigger the debt interest burden of the federal government," said Chris Scicluna, head of economic research at Daiwa Capital.

With price inflation outpacing wage growth, workers are faced with the harsh reality of a rapid deterioration in their purchasing power. That strain is likely to hit harder for some households than others, particularly younger borrowers with lower incomes.