The Fed should pause in October—bond markets have already priced in the tightening

“The Fed is likely to leave the Federal Funds target range at 3.75 to 4.00 percent, and that’s the right move. While inflation, at 3.4 percent, is still too high, it stems primarily from energy prices: gas costs 34 percent more than a year ago. Higher interest rates do little to address this. There is no threat of a wage-price spiral, as wages are rising at 3 percent—a slower pace than prices. At the same time, the labor market is cooling significantly: only 29,000 new jobs were created in September, and jobs were even lost in July.

Another rate hike at this point would be premature—not least because the shift in longer-term interest rates has long since taken place. The yield on 10-year US treasury bonds reached 5.31 percent in early October, its highest level since 2002; according to Freddie Mac, 30-year mortgages cost 7.3 percent—in each case, more than one percentage point higher than a year ago, even though the federal funds rate is lower today. According to a Federal Reserve model estimate, only about half of the rise in yields is attributable to higher expected policy rates—including the rate hike anticipated by the markets for December—while the other half is due to an increased term premium. However, the Fed must keep a close eye on inflation expectations. Households, at least in the short term, expect high energy prices to persist to a much greater extent than experts do. If this expectation takes hold, it will intensify price pressures.

The rise in interest rates is hitting the heavily indebted US government hard: According to a preliminary estimate by the Congressional Budget Office, net interest payments rose by 11 percent to USD 1.14 trillion in fiscal year 2026—more than one in five dollars of government revenue goes toward debt service. At the same time, the inflation-adjusted yield on 10-year bonds has barely risen—to about 2.3 percent—while the real yield has increased by nearly one percentage point. The markets are therefore not questioning the Fed’s inflation target, but are demanding greater compensation for holding long-term US debt given a USD 2 trillion deficit. The central bank must not allow itself to be swayed by this. The problem must be addressed by Congress following the midterm elections on November 3.”