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US borrowing costs hit the highest level since 2007 after the Federal Reserve held rates steady, underscoring fears that the central bank will not be able to contain the inflationary shock from President Donald Trump’s war in Iran.
The 30-year Treasury yield rose as much as 0.14 percentage points to 5.23 per cent following the Fed decision on Wednesday, in the biggest jump since Trump’s “liberation day” tariff announcement in April 2025, signalling worries among investors that surging oil prices triggered by the Middle East conflict could prompt a lasting bout of inflation.
The yield remained elevated on Thursday morning at about 5.22 per cent.
Fed chief Kevin Warsh vowed not to “waver” in the central bank’s battle to cool US price growth after the Federal Open Market Committee left its main rate at 3.5 to 3.75 per cent for the fifth straight meeting. He also argued that a rise in bond yields between the June and July Fed meetings had essentially tightened monetary policy.
“Financial market prices in this intervening period, they didn’t pause. They reacted to the inflation data in one direction, strong economic growth in the other direction, and nominal and real rates went up,” Warsh said at a press conference following the meeting.
Markets had predicted a roughly one-in-three chance that the Fed would raise rates on Wednesday, unusually high odds that had prompted some investors to wager that the central bank could deliver a surprise increase.
The decision to leave rates on hold, coupled with Warsh’s focus on market moves between meetings, unnerved some traders in the world’s biggest debt market.
“Warsh’s answer on inflation today seemed to be ‘we’re letting the market do our work for us’,” said Lou Brien, economic strategist at DRW Trading. “That was not a good enough answer for the market.”
Robert Sockin, chief US economist at PGIM, said: “The biggest failure of the press conference was that Warsh didn’t explain why they didn’t hike.”
He noted that the jump in long-term bond yields would be a “real point of worry”, adding: “They’re going to be worried that they’re losing credibility and will double down on the hawkishness in the coming weeks.”
The two-year Treasury yield fell sharply on Wednesday as longer-dated bond yields rose, as investors bet that interest rates would remain low in the short term but that inflation could rise in years to come. The two-year yield later drifted higher to trade around 4.28 per cent on Thursday morning, down from about 4.34 per cent before the Fed decision.
US stocks fell sharply as borrowing costs rose, leaving the broad S&P 500 down 1.5 per cent. The Nasdaq 100, which is full of tech stocks that are vulnerable to rises in bond yields, fell 2.1 per cent.
Wednesday’s decision drew dissents from a trio of FOMC members — the Dallas Fed’s Lorie Logan, Cleveland’s Beth Hammack and Minneapolis’s Neel Kashkari — who argued that borrowing costs should be raised immediately.
The dispute came as many investors were wagering that the Fed would need to raise rates soon when soaring oil prices threaten to ignite another broad bout of price growth.
“The FOMC delivered a hawkish hold,” said Marc Giannoni at Barclays, noting the “significant hawkish resistance from those who preferred to hike immediately rather than wait out data developments”.
But during the post-meeting press conference, Warsh insisted “this Fed will not waver” in its commitment to tackling inflation. “Our credibility rests on performing our duties and delivering on our responsibilities,” he said.
Petrol and diesel prices have shot higher since the Fed’s previous meeting in June as hostilities in Iran have flared up, and traffic through the Strait of Hormuz has slowed to a near trickle. Trump warned on Wednesday that he would deliver a “beating” to Iran, following the Islamic republic’s latest attack on US military installations.
While central bankers prefer focusing on less volatile components of inflation, some economists fear that the rise in energy prices will lead to a broader increase in costs for consumers and businesses.
The war has also exacerbated the effects of Trump’s tariffs and the AI boom in driving up price pressures in the world’s largest economy.
Warsh insisted that the central bank was prepared to do what is needed to bring inflation, which registered 4.1 per cent in May, to the Fed’s 2 per cent goal, which it has failed to hit for more than five years.
Simon Bowmaker, an economics professor at NYU, said Warsh faced a “big challenge” in the months ahead as the split deepens among policymakers over whether and when to raise rates.
“Every Fed chair gets tested at some point — and I’m getting the impression that Warsh is going to be tested sooner rather than later.”
