Bond market is skeptical of Fed’s `wishful thinking’ on at least 10 quarter-point rate hikes through 2023

35375 bond market is skeptical of feds wishful thinking on at least 10 quarter point rate hikes through 2023

Bond traders are doubtful about the Federal Reserve’s ability to deliver a total of at least 10 quarter-point rate hikes in the next two years without substantially undermining U.S. economic growth and employment.

Treasury yields fell across the curve on Thursday — with some of the biggest declines coming in 1- and 2-year maturities. One

TMUBMUSD01Y, 1.197%

to two year

TMUBMUSD02Y, 1.944%

yields would ordinarily be moving higher in response to confirmation of a more hawkish Fed. Instead, Thursday’s rally in government bonds, which pushed yields down, reflects a flight-to-quality move by investors and the market’s latest view that the U.S. is heading for lower growth, observers say.

Thursday’s broad-based drop in yields was accompanied by a U.S. stock market struggling for direction earlier on Thursday, before all three major benchmarks

DJIA, +0.80% SPX, +1.17% COMP, +2.05%

bounced back in the afternoon.

“Definitely, the market is questioning the optimistic scenario laid out in the Summary of Economic Projections, in which rate hikes do not have an impact on employment and growth,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale in New York.

Policy makers’ forecasts, which call for a total of seven quarter-point hikes in 2022 and three to four more next year, “are orchestrated for a soft landing,” she said via phone. “But it’s a bit of wishful thinking to think there will be no impact on employment, given how hawkish the Fed might be on rate hikes. Either the Fed isn’t able to deliver that many hikes, or it delivers that many hikes and that leads to a much more dramatic slowdown in growth and rise in the unemployment rate.”

Wednesday’s aggressive flattening of the Treasury yield curve took a bit of a breather on Thursday, with the spread between the 2- and 10-year yields

TMUBMUSD10Y, 2.153%

hovering below 23 basis points, one of the lowest levels since March 2020. The widely followed spread has plummeted from as high as 1.6 percentage points last March, and traders remain on guard for the prospect that it might fall below zero soon, an inversion which typically signals an impending recession. Meanwhile, the probability of stagflation across the globe is turning into what Barclays PLC

BARC, -0.66%

strategists Maneesh S. Deshpande, Japinder Chawla and Stefano Pascale are calling “a non-trivial possibility.”

“The curve movement is the most compelling part of what’s happened over recent days because that’s where recession risks start to show up,” Tom Porcelli, chief U.S. economist for RBC Capital Markets in New York, said via phone. “The market is priced for 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 some slowing economic activity.”

If Fed officials hike rates according to their projections, they would be pushing the fed funds rate target up to 2.8% by the end of 2023, from 0.25% to 0.5% currently. That would be the highest level since 2008.

In the process of delivering 10 to 11 quarter-point hikes over the next two years, policy makers anticipate U.S. economic growth will come in at 2.8% for 2022 before slipping down to 2.2% by the end of 2023. Their projections also assume the unemployment rate will stay roughly constant — 3.5% in 2022 and 2023, and 3.6% in 2024 — while inflation drops toward more normal levels below 3% starting next year.

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

“The markets continue to digest the implications of yesterday’s Fed move,” he wrote in an emailed note Thursday, “as the Fed moves from one horn of the dilemma (behind the inflation curve) to the other horn (recession fears).”

Source: Marketwatch

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