The bond market is skeptical of the Fed’s “wishful thinking” of at least 10 quarter-point rate hikes through 2023

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The bond market is skeptical of the Fed’s “wishful thinking” of at least 10 quarter-point rate hikes through 2023


Bond traders doubt the Federal Reserve’s ability to make a total of at least 10 quarter-point rate hikes over the next two years without substantially compromising economic growth and employment in the United States.

Treasury yields fell along the curve on Thursday, with some of the largest falls coming to maturity at 1 and 2 years. A BX: TMUBMUSD01Y
at two years BX: TMUBMUSD02Y
yields would normally rise in response to confirmation of a more aggressive Fed. Instead, Thursday’s rally in government bonds, which pushed yields lower, reflects a flight move towards quality by investors and the latest market view that the US is heading for more growth. low, observers say.

Thursday’s large decline in yields was accompanied by a US stock market fighting for direction early Thursday, ahead of all three major DJIA benchmarks


rebounded in the afternoon.

“Surely, the market is challenging the optimistic scenario outlined in the Economic Projection Summary, where rate hikes do not have an impact on employment and growth,” said Subadra Rajappa, head of US rate strategy at Société. Générale of New York.

Policymakers’ forecasts, which predict a total of seven quarter-point hikes in 2022 and another three or four next year, “are orchestrated for a soft landing,” he said over the phone. “But it is a bit of wishful thinking that there will be no impact on employment given how aggressive the Fed could be on rate hikes. Either the Fed is unable to provide that many hikes, or it makes so many hikes and that leads to a much more dramatic slowdown in growth and a rise in the unemployment rate. “

Wednesday’s aggressive flattening of the Treasury yield curve took some respite on Thursday, with the spread between 2-year and 10-year yields BX: TMUBMUSD10Y
hovering below 23 basis points, one of the lowest levels since March 2020. The widely followed spread tumbled from a high of 1.6 percentage points last March and traders remain on guard against the prospect of it falling below zero soon, a reversal that typically signals an impending recession. Meanwhile, the probability of worldwide stagflation is turning into what Barclays PLC UK: BARC
strategists Maneesh S. Deshpande, Japinder Chawla and Stefano Pascale define “a non-trivial possibility”.

“The movement of the curve is the most compelling part of what has happened in recent days, because that is where the risks of recession begin to manifest themselves,” Tom Porcelli, US chief economist for RBC Capital Markets in New York, said over the phone. “The market expects seven hikes this year, based on fed funds futures. So the flattening of the yield curve suggests that maybe the Fed does what it says it will do, but that comes with a risk, which is a slowdown in economic activity. ”

If Fed officials raised rates according to their projections, they would push the federal funds rate target to 2.8% by the end of 2023, from the current 0.25% to 0.5%. It would be the highest level since 2008.

In the process of rising from 10 to 11 by a quarter of a point over the next two years, policy makers predict that U.S. economic growth will reach 2.8% by 2022 before slipping to 2.2% by the end of. 2023. Their projections also assume the unemployment rate will remain nearly constant – 3.5% in 2022 and 2023 and 3.6% in 2024 – while inflation will drop to more normal levels below 3% starting next year. year.

“Investors are skeptical that the Fed will achieve a soft landing,” said Marc Chandler, chief market strategist at Bannockburn Global Forex.

“Markets continue to digest the implications of yesterday’s Fed move,” he wrote in an e-mailed Thursday note, “as the Fed moves from one horn of the dilemma (behind the inflation curve) to another. (fears of recession). ”


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