BNP Paribas cools bond-market jitters on Fed interest-rate hikes

17 May 2026, 14:07 · The Fresno Bee

After an especially bruising week of hot back-to-back inflation headlines, increasing uncertainties about the end of the Iran war's energy shocks, and a flaccid state visit to China, the bond market's outlook for a Fed interest-rate hike this year flexed.

Long-dated Treasury yields pushed sharply higher, with bond traders upping the risk that the central bank may need to tighten monetary policyrather than ease, as was expected at the start of the year.

One major bank dropped a strong warning in response to the bond market's jitters.

BNP Paribas Chief U.S. Economist James Egelhof and Head of U.S. Rates Strategy Guneet Dhingra wrote in an email note to TheStreet that, in the end, their view is the Federal Open Market Committee is likely "to strongly prefer" a long-term hold stance to rate hikes in 2026.

"We think the FOMC will entertain hikes only in a world of bad choices: either to allow inflation to increase further and become further entrenched into the economy, or to accept the risk that a policy adjustment could prove macroeconomically destabilizing,'' the note said.

The note added that should the Fed begin hiking rates later this year under new Chair Kevin Warsh, "this would create downside risk to our otherwise optimistic economic outlook."

Bond market ups Fed rate-hike forecast

Bond traders have been preparing for higher inflation risks since the Iran war began in late February.

And that preparation includes the possibility that the central bank will need to raise interest rates sooner than anyone expected, especially incoming Fed Chair Kevin Warsh.

The CME Group FedWatch Tool raised the probability of a quarter-point rate hike this year to 50% on May 15, up from 10% the previous day's odds of 40%.

The 30-year Treasury yieldtopped the 5% threshold this week, according to MarketWatch, and the benchmark 10-year yield hit the 4.5% mark May 15 for the first time since June 2025. The two-year yield rose above 4% for the first time in 11 months.

Inflation rises, jobs stabilize in latest reports

Economists are broadly forecasting that the April Personal Consumption Expenditures inflation report - the Fed's preferred inflation gauge due May 28 - will remain elevated and reinforce expectations that the central keeps the benchmark Federal Funds Rate higher for longer.

The Bureau of Economic Analysis released the March PCE on April 30 showing an acceleration in headline inflation largely driven by energy costs.

Headline PCE (year over year): 3.5%, up from 2.8% in February
Core PCE (year over year): 3.2% (excluding food and energy), up from 2.9% in February

The Bureau of Labor Statistics on May 13 said the April Producer Price Index jumped 6%, the biggest year-over-year increase since 2022.

The April Consumer Price Index released on May 13 also jumped 3.8% year over year. It outstripped workers' earnings for the first time in three years, marking the highest inflation print since the post-pandemic recovery in May 2023.

The headline CPI climbed 0.6% from March, while the core gauge, excluding food and energy costs, rose 0.4%.
Energy prices soared 17.9% year over year, with gas prices up 28.4% and fuel oil prices up a whopping 54.3%.

The Fed's own annual target of 2% inflation has not been met in five years, mostly due to the impact of the pandemic.

Despite the rising energy costs fueled by the Iran war, U.S. employers added more jobs than expected for a second month in April, and the unemployment rateheld steady at 4.3%, the Bureau of Labor Statistics reported.

Fed's mandate requires a tricky balance

The Fed's dual mandate from Congress requires maximum employment and stable prices.

Lower interest rates support hiring but can fuel inflation. This risks fueling further inflation, potentially leading to an inflationary spiral.
Higher rates cool prices but can weaken the job market. This increases the cost of borrowing and further stifles economic activity.

The FOMC continued to hold the funds rate - which impacts the cost of short-term borrowing - steady at 3.50% to 3.75% during its April 30 meeting.

This came after policymakers cut rates by a quarter point at each of the last three meetings of 2025 to shore up the softening labor market.

The next FOMC meeting is June 16-17 and will be the first with Warsh as chair.

President Donald Trump and other White House officials repeatedly called for the central bank to slash rates dramatically in the last year to 1% or lower.

Warsh has said the Fed needs to lower interest rates under a "regime change" packed with multiple reforms.

What is the BNP Paribas outlook on Fed interest rates?

Were the FOMC to decide on raising rates, BNP Paribas said it would most likely begin to do so at its December 2026 meeting.

"While we acknowledge that Fed Chair Warsh is unlikely to want to hike rates early on in his leadership of the Fed, our view is that regardless of who leads the central bank, monetary policy will be determined by the economic outlook and by the FOMC's existing policy goals and strategy, in whatever direction the data leads,'' the note said.

The note said that the U.S. economy is more keyed into financial conditions and forward-looking expectations than it was in the past, and that a "re-rating of valuations driven by a shift in investor psychology" could have a significant impact on the economic outlook.

"We also think that the rationale of hikes matters: We would be relatively less concerned about a negative response in equities if hikes were motivated by a strong growth outlook and a declining unemployment rate, and more concerned if hikes were motivated by rising (long-term inflation expectations) LTIE,'' the note added.

While markets have gradually been pricing the risk of a rate hike in 2027, "hikes could be more front-loaded (starting in December 2026) and also in a cluster (three hikes back-to-back), as opposed to a shallow buildup to a hike that markets seem to be expecting."

"We think the options market offers an attractive structure to play for this scenario,'' the note said.

The Arena Media Brands, LLC THESTREET is a registered trademark of TheStreet, Inc.

This story was originally published May 17, 2026 at 7:07 AM.