Wall Street hedges swell to record highs as surprise rate-hike bets gain traction Fed holds rates to await further data, prompting an unwinding of excessive tightening bets Warsh ushers in a new monetary-policy regime: “Watch the ball, not the referee”
The US Federal Reserve put the brakes on mounting speculation about a surprise rate hike by holding its benchmark interest rate steady at the July meeting of the Federal Open Market Committee (FOMC). Although inflation concerns had intensified enough for three officials to call for a 0.25-percentage-point, or 25-basis-point, increase, the majority opted to gather more evidence on the persistence of price pressures stemming from the Middle East energy shock, artificial intelligence (AI) investment and tariffs. With the Fed emphasizing the need for additional data, investors quickly unwound bets that had interpreted the central bank’s silence as a signal of impending tightening. As newly appointed Fed Chair Kevin Warsh maintains a communications policy aimed at reducing advance policy signals, the longstanding market practice of relying on the chair’s remarks to gauge the policy outlook is also entering a period of transition.
Fed Holds Rates at 3.50–3.75% in 9–3 Vote
On July 29 local time, the Fed announced after its two-day regular FOMC meeting that it had decided to maintain the federal funds rate at an annual target range of 3.50–3.75%. The decision was approved by nine of the committee’s 12 members, with three dissenting. Unlike the June meeting, when all 12 members unanimously voted to hold rates steady, Cleveland Fed President Beth Hammack, Minneapolis Fed President Neel Kashkari and Dallas Fed President Lorie Logan dissented this time, arguing for a 0.25-percentage-point increase. These were the first dissenting votes under Warsh’s leadership. It was also the first time since September 2016 that three officials had dissented in the same direction, with all of them advocating a rate increase.
The split appears to reflect renewed inflationary pressure in the United States as escalating war with Iran pushes up global oil and energy prices, while rising semiconductor and electricity costs driven by expanding AI investment intersect with the tariff policies of the Donald Trump administration. Immediately before the rate decision, the Chicago Mercantile Exchange’s CME FedWatch Tool showed that markets had priced in roughly a one-in-three chance of an unexpected rate increase at the meeting.
In its monetary-policy statement, the Fed said, “Although uncertainty has increased amid the conflict in the Middle East and other developments, economic activity continues to expand at a solid pace,” adding that “productivity growth and capital investment remain strong, employment gains are keeping pace with labor-force growth, and the unemployment rate has changed little.” It continued, “Inflation remains above the Committee’s 2% objective, partly reflecting supply shocks that have raised prices in energy and certain other sectors,” emphasizing that “the Committee will achieve price stability.”
Warsh Moves to Curtail Forward Guidance
Warsh also underscored his commitment to containing inflation at the press conference following the FOMC meeting. “Five years of elevated inflation have left some households, businesses and market professionals with the mistaken impression that the Fed has implicitly raised its inflation objective above 2%,” he said. “The inflation target has not been relaxed.” He reiterated that “the Fed has only one target, and that is 2%.”
Warsh also struck a firm tone on the future course of monetary policy. “The Fed’s decisions matter enormously,” he said. “When action is necessary and appropriate, the Fed will not hesitate to act.” At the same time, he did not rule out another rate increase, noting that “if inflation remains persistently elevated, higher rates could also be part of the solution.” Analysts said Warsh continues to adhere to his position of offering the market fewer clues about the future path of interest rates. The policy is widely interpreted as an attempt to compel investors to absorb and price policy uncertainty on their own.
Table 1. US Rate-Hike Expectations and Market Responses Ahead of the July FOMC Meeting
| Category | Key Details | Principal Figures | Interpretation |
|---|---|---|---|
| Rate-hike bets | Rising oil prices caused by the Iran war and Warsh’s silence fueled expectations of earlier monetary tightening | July hold: 68.5%; 0.25-percentage-point increase: 31.5%; probability of higher rates by September: 77.4% | Markets began pricing in a surprise rate hike in earnest |
| Futures-market hedging | Wall Street traders expanded federal funds futures positions ahead of the July FOMC meeting | August contracts rose from 910,000 on July 24 to 967,000 on July 28 | Interest-rate hedging reached an all-time high, surpassing the previous record |
| Options-market hedging | Demand increased for swap options that profit when long-term borrowing costs rise | Options to pay a fixed rate and receive a floating rate | Defensive demand expanded against the risk of rising long-term interest rates |
| Extreme rate scenario | Some investors hedged against the possibility that the 10-year swap rate would rise to 6% | Current level of 4.23% to 6%, an increase of approximately 1.77 percentage points | Reflected the possibility of substantial policy-rate increases or intensifying concerns over inflation and fiscal deficits |
Market Misreads Warsh’s Approach and Bets on a Surprise Rate Hike
Since taking office last month, Warsh has made clear that excessive advance signaling by the Fed could undermine policy flexibility. He believes that public remarks by individual officials and precisely mapped policy trajectories encourage a competition to “read the Fed” rather than prompting markets to assess risk independently. Accordingly, he has opted to reduce the role of forward guidance and allow actual economic data and financial-market prices to shape policy expectations.
Even so, expectations of a surprise rate hike spread rapidly immediately before the decision. According to the CME FedWatch Tool, one day before the meeting the probability of a July hold stood at 68.5%, while the probability of a 0.25-percentage-point increase had risen to 31.5%. The likelihood that rates would be higher than their current level by September reached 77.4%. With the Iran war driving up global oil prices and Warsh remaining silent, investors bet that the Fed might begin tightening earlier than markets had anticipated.
As uncertainty swept through financial markets, Wall Street traders built record-sized hedging positions around the July rate decision. Open interest in August federal funds futures reached approximately 910,000 contracts on July 24, surpassing the previous record set by the October 2024 contract. By July 28, it had expanded sharply to 967,000 contracts. Demand also rose in the interest-rate options market for swap options that generate profits when long-term borrowing costs increase. These options confer the right to pay a fixed rate and receive a floating rate, meaning their value rises as market interest rates climb.
Some investors also prepared for the possibility that the US 10-year swap rate, currently around 4.23%, could rise as high as 6%. That would be approximately 2 percentage points above its present level. For the 10-year swap rate to reach 6%, the Fed would need to raise its policy rate substantially, or long-term yields would have to surge independently of monetary policy because of mounting concerns over inflation and the fiscal deficit. Guneet Dhingra, head of US rates strategy at BNP Paribas, said in this regard, “The market has begun to show greater conviction than before that a rate hike is possible.”
“Watch the Ball, Not the Referee”
Warsh, however, made clear from his first FOMC meeting that he would not provide policy signals in advance. In the official statement issued at the time, he substantially stripped out forward-looking language and reduced references hinting at the future path of interest rates. The move reflected his concern that the practice of predicting monetary policy by parsing the frequency and tone of Fed officials’ remarks distorts the meaning of economic data and turns market prices into replicas of the central bank’s forecasts. His silence is therefore viewed not as coded guidance foreshadowing a hawkish decision, but as an institutional choice intended to foster independent price discovery by markets.
As a result, bets that had interpreted the Fed’s silence as a signal of a rate increase were rapidly unwound after the policy announcement. Following Warsh’s press conference, the probability of a September increase fell from 77.4% the previous day to 53%, while the likelihood of an increase by year-end also declined. Economic indicators released before the meeting pointed simultaneously to easing inflation and weakening employment momentum, yet some market participants attached excessive policy significance to the chair’s lack of public commentary. The entrenched habit of reading the Fed’s expression before examining the data ultimately produced flawed probability estimates and heightened short-term interest-rate volatility.
With parts of the market having misjudged the policy outlook by attempting to infer direction from the Fed’s silence, Warsh again reminded investors of the role he expects them to play. At the latest press conference, he said in substance that market participants should “watch the ball, not the referee.” The message was that they should stop expending their resources trying to anticipate the Fed’s next move and instead assess developments in the real economy and financial markets directly. Underlying this view is a recognition that when policymakers commit in advance to future action, they become less able to adjust their decisions as new data emerge, potentially triggering controversy over the loss of institutional credibility.
The Warsh Fed is also broadening the range of inputs used in monetary-policy decisions. The central bank has launched five task forces to review data use, communications, the balance sheet, the inflation-targeting framework, and the economic effects of AI and productivity. The initiative is seen as an effort to reduce mechanistic responses to monthly employment and inflation data and establish a policy framework that simultaneously incorporates capital investment, productivity, supply chains and financial conditions.
The Fed as We Knew It Is Over
This month’s decision to hold rates steady marked the end of “the Fed as we knew it.” In the past, the central bank used speeches and projections to steer markets in its preferred direction, but Warsh is shifting the center of gravity in monetary policy toward a system in which markets interpret the economy and form prices first. Analysts say investors who assigned an excessive probability to a rate increase paid the price for treating Warsh’s silence purely as a source of uncertainty. One economist said, “As the symbiotic relationship between a market that followed every word of the Fed chair and a central bank that carefully rationed its messages begins to unravel, a new regime is taking shape in which data and prices move to the forefront of monetary-policy judgment.”
As Warsh’s communications framework becomes more firmly established, the burden on financial markets to interpret policy is expected to increase further. In an environment where the Fed does not provide a detailed preview of the future rate path, short-term interest-rate volatility around FOMC meetings is bound to increase, while individual economic indicators will exert greater influence over policy expectations. Market participants will therefore need to move beyond interpreting the chair’s choice of words and calculate their own policy probabilities by assessing the Consumer Price Index (CPI), Personal Consumption Expenditures (PCE) price index, employment, wages, oil prices, inflation expectations and Treasury yields in combination. As the era in which the Fed mapped out the rate path in advance draws to a close, responsibility for forecasting monetary policy is also shifting to the market.