Fed Pauses as Warsh Turns Hawkish: Treasury Longs Risk a Squeeze

The FOMC is scheduled to release its decision at 2 a.m. Beijing time Thursday. Markets broadly expect the Federal Reserve to keep its benchmark rate unchanged after a 25-basis-point increase in September, while attention centers on Chair Kevin Warsh's policy signals. CME FedWatch futures imply about a 10% probability of a rate increase at this meeting and a probability above 80% for a December increase. September headline CPI rose 3.7% year on year, driven mainly by higher energy prices, while core CPI increased 2.6% year on year, 0.3 percentage points above August and above the Fed's 2% target. Treasury positioning is a central market focus. Citi strategist David Bieber said investors have shifted toward tactical long positions in U.S. and European government bonds ahead of the meeting, although the broader market remains net short. JPMorgan's weekly survey showed net Treasury longs at their highest level since early September. Large position closures were concentrated in 10-year Treasury-linked futures last Friday, after the Treasury market recorded its best trading day in more than two years the prior day. Options hedging costs for further declines in 10-year Treasury yields rose to their highest level since March. Some options strategies target a 10-year yield of about 4.6% in coming weeks. A more hawkish inflation message from Warsh could prompt traders to reassess long bond positions and expectations for further policy tightening.