Fed rate hike: bond danger grows as the Fed is about to break with its cautious past
Fresh waves of selling have engulfed the Treasury market over the past week, rattling investors and analysts who have tried to predict how far yields will go.
On Monday, Barclays Plc threw in the towel on a little over a week-old bet that the selloff had gone too far. On Wednesday, Bank of America Corp. said it seemed like it was time to buy, a call that went wrong the next day. Federal Reserve Chairman Jerome Powell’s endorsement on Friday of aggressive actions to rein in inflation prompted traders to rush to price interest rate increases of half a percentage point during of the next four bank meetings, anticipating a sharp break with its decades-long practice of monetary tightening. policy at a gradual pace.
“It’s a tornado right now,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “Fed policy really matters now, and it’s not a takeoff anymore. The question is where are they going?
The signs of investors losing their bearings are everywhere. In options on eurodollar futures, a proxy for the Fed rate, demand for deep out-of-the-money structures offering protection against a series of 75 basis point rate hikes this year has arisen. In the Treasury futures market, block trades have proliferated. And Hoisington Investment Management, famous for its bullish outlook on Treasuries over the past three decades, issued a rare note of caution in its quarterly report to clients.
The week’s volatility extended the tumultuous run of the world’s largest bond market as the Fed begins to withdraw the massive monetary stimulus it unleashed shortly after the pandemic began. Already in 2022, Treasuries have lost more than 8%, by far the worst start in the history of a Bloomberg index since 1973.
The selloff was fueled by investors who have steadily raised their expectations for Fed rate hikes this year, despite continued divergence over how far it will ultimately go.
On Thursday, Powell appeared to validate the fearmongering camp when he said his rate hikes might be appropriate and called the labor market “unsustainably hot.”
The comments helped boost returns. On Friday night, the two-year Treasury yield, which is highly sensitive to changes in monetary policy, hit 2.69%, up about 23 basis points from the previous week. The 10-year rate ended at 2.9%, up 7 basis points over the week, after hovering around 3% on Wednesday.
Notably, Powell’s remarks and the market’s aggressive pricing of another rate hike failed to prevent rising inflation expectations. The 10-year metric crossed 3% en route to a record high.
“The Fed has lost control of inflation,” Faranello said. “Are they tightening too much, or will inflation ease and help them?”
An uncertain inflation picture and the Fed’s response complicated efforts to predict the longer-term outlook for the bond market.
If prices rise slowly, the Fed may be able to suspend its hikes, leading to a relatively low spike in the overnight lending rate, which the market sees rising not far from the central bank’s current estimate of 2.8% by the end of next year. . It is currently between 0.25 and 0.50%. But there is also a risk that inflation will persist – or that the Fed’s rate hikes will push the economy into a recession.
“Despite all the angst and volatility of the past few months, the market is pricing in a rate-tightening cycle similar to what we’ve seen previously with a maximum implied funding rate of 3.25%,” said Bob Miller, Head of Fundamental Fixed Income Americas at BlackRock Inc. .
“What will determine the Fed and terminal prices is the path of inflation over the next six months,” he said. “A lot of that will determine whether the fed funds will hit 2.5%, 3.5% or something higher.”
What to watch
- April 25: Chicago Fed National Activity Index, Dallas Fed Manufacturing Activity
- April 26: Durable Goods Orders, FHFA House Price Index, S&P CoreLogic House Prices, Conference Board Consumer Confidence, New Home Sales, Richmond Fed Manufacturing Index
- April 27: Mortgage applications, wholesaler inventories, pending home sales
- April 28: Q1 GDP Up, Unemployment Insurance Claims, Kansas City Fed Manufacturing Activity
- April 29: Employment cost index, personal income and expenditure (with PCE deflator), University of Michigan sentiment and inflation expectations
No central bank speeches planned
- April 25: 13 and 26 week invoices
- April 26: Two-year tickets
- April 27: two-year floating rate notes, five-year notes
- April 28: 4-week and 8-week bills, seven-year bills