Morning Bid: Bond markets doing the Fed's work

A look at the day ahead in European and global markets from Ankur Banerjee

A divided Federal Reserve and a confusing message from Chair Kevin Warsh on where rates are headed has left the bond market scratching its head and somehow in charge, in an odd reversal that raises questions about the central bank's credibility.

The U.S. central bank stood pat, as expected, but three dissenters underscored the growing divide among policymakers on the next steps in combating inflation that remains above the Fed's target of 2%.

Warsh vowed to contain inflation but gave no indication of the steps the central bank might take, noting that bond yields had risen notably since the Fed's last policy meeting, reflecting market expectations of higher interest rates.

He welcomed the rise in short-term bond yields, while stressing that it did not oblige the Fed to validate those expectations with policy action.

All that talk with no action is not a good look for a central bank that is aiming to convince that its independence is not under threat.

"Talking hawkish but not acting so reduces the Fed's credibility," said Wall Street veteran Ed Yardeni. "We conclude that the Fed has to raise short-term rates to lower long-term rates."

Bond investors on Thursday shifted the prevailing dynamic as the Treasury curve steepened. The yield on the inflation-sensitive 30-year U.S. bonds rose to 19-year highs. [US/]

Meanwhile, fears around the AI trade kept sentiment fragile, although the selloff on Thursday was not as steep as earlier this week. Earnings from Samsung and Microsoft helped soothe nerves but a huge drop in Meta's cash flows underscored the challenge facing these firms to deliver returns on massive spending.

A policy decision from the Bank of England is due later in European hours with the central bank likely to keep interest rates steady as it weighs the impact of the Iran war that has closed the Strait of Hormuz for the past five months and intensified inflation pressures.

Key developments that could influence markets on Thursday:

Economic events: Bank of England policy decision, Q2 GDP and July sentiment data for euro zone, July inflation for Germany

(By Ankur Banerjee in Singapore)