After last week’s Fed meeting, bond investors began to abandon strategies that steepened the yield curve.
Bond investors have updated their expectations after the Fed’s “hawkish” hiatus from rate hikes last week and two Fed officials’ statements supporting further tightening, pricing in that short-term bond yields will rise faster than long-term ones.
Investors, who previously thought that the Fed could end interest rate hikes and cut rates at the end of the year, started to abandon the strategy that steeped the yield curve after the rate forecasts for the year were raised by 25 basis points last week.
At one point on Friday evening, the yield on 2-year US bonds rose 98 basis points above the yield on 10-year bonds. This difference had risen to 111 basis points at some point in March. The statements of Fed officials were also effective in the rise on Friday.
Fed Governor Christopher Waller pointed out that core inflation is still high, emphasizing that “more tightening may be required”; Richmond Fed President Thomas Barkin said he would be “comfortable to do more” if inflation didn’t return “relatively fast” from 4 percent to 2 percent.
Kevin Flanagan, Director of Fixed Income Strategy at WisdomTree, said: “The market is in a situation where the Fed is potentially still in an active rate hike cycle and the two-year bond looks expensive. “Even if the Fed only keeps interest rates at 5% to 5.25%, yields on 2-year bonds could approach 5%,” he said.
The market is too optimistic, according to Goldman
Goldman Sachs Group Inc. According to strategists, inflation in the US will not fall as fast as the markets are currently pricing.
Strategists led by Praveen Korapaty said in a note released on Friday that investors may be pricing in that a rapid slowdown in growth will cause price pressures to recede faster, and that they are more pessimistic about energy prices than commodity futures imply.
The strategists, who foresee that these two factors will have a limited effect in bringing down inflation, stated that the markets also ignore the potential of “delayed inflation” in sectors such as health. “Although we expect further declines in inflation going forward, markets seem much more optimistic than we are about the rate of cooling,” the note said.