Warsh hiked, Carney pivoted
Why did the U.S. Federal Reserve raise its interest rate?
The U.S. Federal Reserve (the Fed) raised its benchmark interest rate by a quarter of a percentage point Wednesday to a range of 3.75% to 4%, its first increase since July 2023. The vote was unanimous at 12-0. Furthermore, 16 of 18 Fed policymakers expect another rate increase this year, four of them see two, and no increases appear in the years that follow. Inflation forecasts crept higher, to 3.7% headline PCE (Personal Consumption Expenditures Price Index, a key measure of U.S. inflation) and 3.4% core (PCE minus food and energy).
Fed Chair Kevin Warsh described the decision as “removing a dose of accommodation” (dialing back on a policy that was stimulating the economy) and repeated that this summer’s readings give him no evidence that underlying inflation trends have improved. Stocks were flat on the initial announcement and dipped lower while he spoke.
U.S. President Trump selected Warsh expecting lower rates and said days earlier that no country should have rates lower than America’s. Warsh voted to raise them anyway. A Fed chair establishing independence this early will change how markets will read every meeting from here, and it removes the assumption that the White House is setting the ceiling on rates.
How high did 10-year Treasury yields climb?
The case for raising rates strengthened during the week. Houthi forces seized more islands along Red Sea shipping lanes, and an attack knocked Saudi Arabia’s East-West pipeline offline, with officials saying repairs will run for weeks. The supply shock has widened from Iranian waters to Saudi infrastructure. Brent crude oil traded close to $107 per barrel.
U.S. 10-year Treasury yields pushed above 5% Tuesday, near a two-decade high. That level will affect every discount rate (the interest rate used to value investments) in every type of bond, and it arrived in the same week the Fed raised its interest rate.
Canadian stocks felt it; The S&P/TSX (an index of Canada’s biggest companies) closed Monday at 35,703 after a mixed domestic inflation report, then slid by 0.67% Tuesday (with energy providing the only real support), following its worst weekly decline since March. The index that spent the summer outrunning the S&P 500 (the index of the U.S.’s biggest companies) is now being tested by the same oil prices that lifted it.
What’s happening with Canada and the E.U.?
The biggest Canadian news had nothing to do with rates. In her state of the union address Wednesday, European Commission President Ursula von der Leyen invited Canada to become the European Union’s first associate member and described it as an alliance for the future. Prime Minister Mark Carney addressed the European Parliament in Strasbourg Thursday, welcomed the ambition (though he ruled out full membership) and proposed joining Erasmus+ (the European Commission’s program supporting education, training, youth and sport) and Horizon Europe (the E.U. program for funding research). He committed to a parliamentary debate and vote.
Trump called the idea a hostile act and laughable. Carney answered that Canada and Europe are no fair-weather allies, and that a deeper European partnership will make Canada a better partner to the United States.
Three weeks after Canada’s talks with Washington collapsed and both countries began taxing each other, Ottawa is building an alternative. Markets will not factor in any of this quickly; reduced dependence on a single trading partner will be a structural shift measured in years. The E.U.-Canada summit at the end of October is where its shape will start to matter.
Will the Fed keep raising interest rates?
After a week when the Fed finally moved its rate and Ottawa went shopping for new partners, the question now is how much higher the price of oil needs to go before one rate increase becomes a cycle.
Listen to the latest podcast from the IG Investment Strategy Team for further insights.
