Fed Officials Daly, Musalem Diverge on Policy Urgency as September Hike Odds Plummet
0h ago|5 min readStandard
Fazen Markets Editorial Desk
Collective editorial team · methodology
federal-reserveinterest-rates
Fazen Markets Editorial Desk
Collective editorial team · methodology
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San Francisco Fed President Mary Daly and St. Louis Fed President Alberto Musalem presented a united front against concerns over the Federal Reserve's inflation-fighting credibility on Thursday, August 20, but offered divergent views on the urgency of further policy tightening. Their remarks landed as traders sharply pared bets on a September interest rate increase, with market-implied probability falling to around 30 percent from more than 70 percent at the end of July. This repricing occurred alongside a continued selloff in bonds, with the 30-year Treasury yield climbing to its highest level since 2007. Both officials attributed recent market volatility to fiscal financing needs and capital demands from artificial intelligence investment rather than a loss of faith in the central bank, a stance that may ease acute fears of de-anchored inflation expectations.
The Federal Open Market Committee held its policy rate steady for a fifth consecutive meeting in July, but three policymakers dissented in favor of an immediate hike. This internal division has heightened the market's sensitivity to communications from non-voting officials like Daly and Musalem as investors seek clues about the committee's future direction. The current macro backdrop features persistent inflation readings above the Fed's 2 percent target, with underlying measures in a 2.5 to 3 percent range as noted by Musalem, juxtaposed against recent signs of economic cooling like weaker retail sales and a surprise drop in employment.
The immediate catalyst for the officials' comments was a sustained bond market selloff that has pushed long-term yields to multi-year highs. This turmoil sparked public debate over whether the Fed was losing its grip on inflation expectations, a credibility crisis the officials explicitly sought to counter. The Treasury Department's Wednesday announcement of increased buybacks in longer-dated debt provided only a brief respite, with yields resuming their climb on Thursday. The shift in market pricing for September, from a high likelihood of action to a low probability, reflects a rapid reassessment of the Fed's reaction function amid mixed economic signals.
The shift in rate expectations is the most concrete numerical signal from the event. The probability of a 25-basis-point hike at the September FOMC meeting, derived from futures pricing, collapsed from over 70% on July 31 to approximately 30% by the close on August 20. This 40-percentage-point drop in expectations occurred over just three weeks. Concurrently, the yield on the 30-year US Treasury bond reached its highest level since 2007, a period preceding the global financial crisis. The 10-year yield also trades at elevated levels, contributing to a significant steepening of the yield curve over recent months.
A comparison of key metrics before and after the officials' remarks illustrates the market's prevailing conditions. At the end of July, the market priced aggressive Fed action with a >70% hike chance and long yields were elevated but not at cycle peaks. As of August 20, hike odds are subdued at ~30%, yet the 30-year yield sits at a 19-year high, demonstrating a decoupling of near-term policy expectations from long-term bond market dynamics. In the cryptocurrency sector, which is sensitive to liquidity expectations, NEAR Protocol traded at $1.75, down 1.15% over 24 hours, with a market capitalization of $2.28 billion and 24-hour volume of $187.35 million as of 21:57 UTC today. This underperformance versus traditional risk assets like equities highlights the divergent pressures across asset classes.
Daly's dovish-leaning stance, suggesting policy is in a "good place," supports sectors burdened by high interest rates, such as residential real estate and capital-intensive technology firms. Lower near-term hike odds could provide relief for growth-sensitive equities, particularly the Nasdaq Composite (COMP), which has struggled under the weight of higher discount rates. Conversely, Musalem's undecided but hawkish-tinged commentary, including his stated preference for a July hike, acts as a ceiling on any rally in rate-sensitive assets and may limit how far bond yields retrace. This creates a bifurcated market where short-dated instruments react to the diminished September probability, while the long end of the yield curve remains pressured by structural factors like supply and AI capital demand.
A key limitation of this analysis is that neither official votes on the FOMC this year, so their views are influential but not decisive. The market's primary takeaway is likely the committee's lack of consensus, which breeds volatility rather than clarity. Positioning data suggests traders had built substantial long positions in anticipation of a September hike during July; the rapid unwinding of these bets contributed to the sharp repricing. Flow is now rotating towards assets that benefit from a "higher for longer" but not "imminently hiking" narrative, including certain value-oriented equity sectors and the US dollar, which retains a yield advantage.
The next major catalyst is the Federal Reserve's annual Jackson Hole Economic Symposium, scheduled for August 27-29. Speeches by Chair Powell and other voting members will be scrutinized for signals that either reinforce Daly's patient view or validate Musalem's caution. Following that, the August Non-Farm Payrolls report on September 5 and the Consumer Price Index reading on September 10 will provide critical data ahead of the September 17-18 FOMC meeting. These releases will directly test Musalem's desire to keep an "open mind" and Daly's assessment that recent data has eased pressure.
Key levels to monitor include the 30-year Treasury yield at the 2007 highs; a sustained break above this technical resistance could signal a new regime for long-term borrowing costs. For rate expectations, watch if the market-implied probability for a September hike stabilizes around the 30% level or drifts toward zero. A move back above 50% would require unequivocally hot inflation data or hawkish consensus from voting FOMC members. The performance of the US Dollar Index (DXY) against this backdrop will indicate whether the Fed's mixed messaging is undermining its currency support.
The officials' pushback on credibility concerns aims to maintain public confidence that inflation will return to 2%, which is crucial for long-term financial planning. If investors believe the Fed has lost control, they may demand higher yields on all debt, increasing mortgage and loan rates. By attributing the bond selloff to specific, non-inflationary factors like AI investment, the Fed seeks to prevent a dangerous feedback loop where rising yields themselves fuel inflation fears. For retail portfolios, a contained credibility debate supports stability in bond fund valuations and reduces the risk of a sharp, policy-induced equity correction.
The current divergence resembles the 2016 dynamic, when the committee was split on the pace of hikes after the initial liftoff from zero, leading to a year with only one increase. A more recent parallel is 2023, when disagreements over the persistence of inflation caused volatile expectations. However, the explicit discussion of credibility as a market driver is less common, echoing aspects of the early 1980s when then-Chair Paul Volcker aggressively raised rates to restore lost credibility. The key difference today is that inflation, while above target, is far from the double-digit levels of that era, giving the committee more room for debate without triggering a crisis of confidence.
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