Markets have started pricing policy risk back into U.S. rates ahead of next week’s Federal Reserve meeting. Even though mainstream economists broadly expect the Fed to leave rates unchanged, interest-rate futures now imply roughly a 30% chance of a hike, a move that has lifted Treasury yields across the curve.
The 2-year Treasury yield has risen to its highest level since early 2025. The 10-year yield has moved to a high for this year, while the 30-year yield has climbed near its highest level since 2007.
Treasury yields climb as markets price a 30% hike probability
Rising oil prices, driven by escalating tensions in the Middle East, have revived inflation concerns and pushed U.S. Treasury yields higher in recent sessions.
On Thursday, the policy-sensitive 2-year Treasury yield rose to about 4.365%. The benchmark 10-year yield also reached a fresh high for the year. The 30-year Treasury yield advanced to 5.19%, just shy of levels last seen in 2007.
At the same time, rate futures showed that markets had priced in about a 30% chance of a Fed rate increase at next week’s meeting. That stands in clear contrast to consensus forecasts. According to a Bloomberg survey, none of the 70 economists polled expected the Fed to raise rates next week.
Citi says the 30% reading is not a market forecast
Citi offered a different explanation for that apparent contradiction in a research report published on July 23.
Economists Andrew Hollenhorst, Veronica Clark and Gisela Young wrote that the 30% figure embedded in market pricing does not mean investors literally see a three-in-ten chance of a rate hike. In Citi’s view, the pricing includes an additional risk premium.
The report said there is little chance of a rate cut at next week’s meeting, which leaves policy risk skewed in one direction. If the Fed were to deliver an unexpected hike, the shock to the bond market would be far larger than the impact of standing pat. Investors are therefore willing to pay an added cost to price in that tail risk ahead of time.
Citi added that, historically, the risk premium around Fed meetings has usually been only 1 to 2 basis points. But as the Fed has reduced forward guidance in recent years and leaned more heavily on data-dependent communication, uncertainty has increased and markets have demanded more compensation.
The same logic extends to longer-dated yields
Citi said the current move in long-end yields can be explained through the same framework. If a future meeting were to produce an unexpected hike, markets would likely interpret it as the start of a new tightening cycle rather than an isolated action. That would also lift expectations for the terminal rate.
For that reason, markets are now pricing in more than 50 basis points of cumulative hikes by March next year. Citi said that should not be confused with investors’ base-case scenario.
Less forward guidance may keep rates elevated
Citi said the recent oil-price increase has acted as a catalyst for markets to reassess the policy path, but the deeper issue lies in changes to the Fed’s communication framework.
The bank said tensions in the Middle East have pushed up oil and U.S. gasoline prices, reinforcing worries that inflation risks are picking up again. With Fed officials offering little clear policy guidance, that uncertainty has magnified concern over policy surprises.
According to Citi, market risk premiums are usually small when forward guidance is clear. Under current conditions, each policy meeting carries greater uncertainty, and investors are paying in advance for protection against unexpected outcomes.
That also means Treasury yields may not fall sharply even if the Fed ultimately leaves rates unchanged. Citi said the effect of risk premiums on yields could persist until the central bank rebuilds a clearer communication framework.