Behind the moderate bond market response to the Federal Reserve’s rate outlook, there may be a message for policymakers
Under the relatively moderate bond market reaction to the Federal Reserve Wednesday’s revised rate outlook is traders’ expectation that the central bank will not go as far as it thinks by raising benchmark key rates.
As equities were higher overall and Treasury yields mixed on what some investors saw as a dovish message from the Fed, the widely observed spread between 2- and 10-year rates flattened, as did the difference between returns at 5 and 30 years. . The flattening came even though policymakers had predicted an earlier-than-expected rate hike for 2022, and said a decrease in monthly bond purchases “may soon be warranted.”
Normally, Treasuries spreads would widen and not narrow, in anticipation of a Fed key rate hike as a better US economic outlook is embedded. Instead, some strategists described the Fed’s message on Wednesday as accommodating, seeing fewer policymakers than expected. called for a first rate hike next year from the current 0% to 0.25% range, and there has been no formal announcement of the cut.
The flattening of the curve was accompanied by a narrowing of the spread between the 2024 and 2026 Eurodollar contracts, the preferred tool for traders to express their opinions on future movements in interest rates. The moves were unusual as traders began to forecast higher odds of a second hike in 2022, which would bring the total of potential hikes over the next several years to eight, thus raising the federal funds rate target between 2% and 2.25%.
Fed officials have never been successful in pushing the Federal Funds benchmark target rate above 3%, even during the longest U.S. economic expansion on record, which was cut short in the last year by the pandemic.
“The Treasury curve flattens on the possibility that the Fed will change course and cut rates after 2024,” said Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York. “This is an interesting dynamic that is also reflected in Eurodollars indicating that once there is a series of rate hikes by Fed officials, the market thinks the Fed may need to ease again . ”
Shares ended sharply higher on Wednesday, with the Dow Jones Industrial Average DJIA,
up more than 300 points, or 1%, while the S&P 500 SPX,
also advanced 1% to reserve their best days in about two months.