Bond market gives mixed verdict on Fed rate forecasts

The sell-off in short-term Treasuries indicated that investors were once again raising their hopes of how higher interest rates could move this year. Early selling in longer-term bonds sharply declined, however, in a sign that investors thought the sharp interest rate hike over the next several months could lead to short hikes later.

The stock climbed, with the S&P 500 rising 2.2% and the tech-heavy Nasdaq Composite up 3.8%.

Beating investor expectations, the central bank on Wednesday raised its benchmark federal-funds rate to a range between minus 0.25% and 0.5%. However, officials have also significantly increased their forecasts of how high rates will rise over the next few years.

Overall, 12 out of 16 executives indicated they thought rates would reach at least a 1.75% to 2% range by the end of the year, with the average forecast ending at around 1.9%. The average forecast for rates by the end of next year was about 2.8%.

“The Fed has sent a strong signal to the market that there is a commitment and will to ease inflationary pressures,” said Gary Pollack, head of fixed-income trading at Deutsche Bank’s private wealth-management arm.

He said investors had already thought that the central bank could raise rates in each of its remaining meetings this year. But they were also betting that the Fed itself would signal more caution in its forecasts Wednesday, leading to a drop in short-term bond prices and an increase in yields when the forecast is released.

According to Tradeweb, the yield on the benchmark two-year Treasury note came in at 1.956% by the end of the session, up from 1.855% on Tuesday. The yield on the 10-year note fell to 2.185%, its highest level since May 2019, but rose marginally from 2.160% on Tuesday and remained virtually unchanged just before the Fed statement. The yield on the 30-year bond fell to 2.456 per cent from 2.503% on Tuesday.

In some ways, analysts said, Wall Street’s response matches recent trends, with investors ready to adjust their interest rate expectations for 2022, but far less flexible from that point on.

For 2023 and 2024, investors are “skeptical,” said Priya Misra, head of global rates strategy at TD Securities in New York. “It’s ahead,” she said. “Things could change. Maybe inflation subsides by then,” especially considering what the Fed will do this year, in terms of raising rates and reducing its bondholding.

Investors and economists pay close attention to Treasury yields because they set a floor on the cost of borrowing in the economy and are an important input into the financial models that investors use to value stocks and other assets.

Heavily influenced by investor expectations for short-term rates set by the Fed, changes in yields can have a direct impact on the economy before the central bank actually changes the rates it directly controls. Already this year, there are signs of a slowdown in housing demand due to rising mortgage rates, which are closely tied to the 10-year Treasury yield.

As long as the US can survive the recession and corporate profits can keep growing, many investors will accept a slightly slower economic growth. US stocks have generally performed well when the Fed has started raising interest rates, mainly because the central bank has taken steps when the economy is in a strong position.

Investors are more nervous than usual this year, with the S&P 500 down 8.6% for the year, as inflation has been higher for decades. One risk is that the Fed may be willing to risk a recession, or accidentally cause one, as it tries to moderate inflation.

This year has already been a tough one for bond investors. When inflation began accelerating last year, for months investors thought it might come down on its own, allowing the Fed to keep short-term interest rates near zero. However, those views changed sharply this year, largely due to a change in the tone of Fed officials, including Chairman Jerome Powell, who began to express more concern about inflation and a call to start raising rates. expressed curiosity.

A significant bond rally this year came in late February when Russia invaded Ukraine for the first time, leaving uncertainty over the economic outlook.

Recently, however, investors have become more skeptical that the invasion may be keeping a lid on interest rates. Some have argued that aggression-induced higher commodity prices could only exacerbate inflation, putting even more pressure on the Fed to tighten policy. Meanwhile, energy prices have already dropped from their recent highs, fueled by hopes of a solution from talks between Russia and Ukraine. This has eased the concern of those who thought higher prices could have the opposite effect: slowing economic growth and making it harder for the Fed to raise rates.

Despite the Fed’s actions on Wednesday, monetary policies – and therefore bond yields – will still be largely determined by the state of the economy.

On that front, new data Wednesday morning showed retail sales rose 0.3% seasonally in February, beating analysts’ forecasts of 0.4%. At the same time, the sales growth for January was increased from 3.8% to 4.9%.

There was little change in the Treasury yield right after the report. In a note to clients, Ian Lingen, head of US rate strategy at BMO Capital Markets, wrote that the data shows “an troubling trajectory”, but an upward revision in January sales “sharp off disappointing February numbers”. have done.”

This story has been published without modification to the text from a wire agency feed