(Bloomberg) — Money market traders are betting that the Federal Reserve is headed for its tightest monetary policy in nearly three decades as it battles a rising commodity-driven inflation.
They are discounting another 225 basis points of interest rate hikes by the end of the year, in addition to the 25 basis point increase in March.
The Fed hasn’t adjusted its rate that much (250 basis points) in a year since 1994, a year famously brutal for bond investors that even included a 75 basis point hike. The last year monetary policy was tightened further was in the early 1980s, when Paul Volcker was in charge of the central bank.
With US inflation approaching 8%, a rate not seen in 40 years, Fed officials have adopted a decidedly more restrictive tone. The prospect of sharp monetary tightening has already led to a slump in global bonds this year, and the latest move in market bets follows Governor Lael Brainard’s comments that the central bank will continue to methodically tighten monetary policy.
“This comes down to what Brainard means by ‘methodical,'” said Marc Ostwald, global strategist at ADM Investor Services.
He says the Fed wants flexibility, but also doesn’t want to constantly change the pace of tightening. Ostwald expects a half-point increase next month and probably in June, followed by quarter-point increases, but the “underlying lack of depth of liquidity in the markets, persistent high volatility will likely come at a high cost and by extension , the Fed will become cautious.”
Bond yields continue to rise
US Treasuries fell for a fourth day on Wednesday, causing yield on 10-year notes rose 10 basis points to a three-year high of 2.65%. That followed Tuesday’s advance that was the biggest since the pandemic first hit in March 2020.
Global pairs were caught up in the sell-off. UK borrowing rates rose 10 basis points to 1.75%, the highest level since 2016, while their German counterparts rose six basis points to 0.68%. Australian pairs fared worse with 10-year yields rising as much as 13 basis points to nearly 3%, the highest since 2015.
As the inflationary backdrop worsens, Fed Chairman Jerome Powell and several other monetary policymakers have indicated they are willing to raise US rates in 50 basis point increments if necessary.
Given the there are six meetings scheduled for this year, current haircuts would equate to three half-point increases and three quarter-point increases, assuming the Fed raises borrowing costs on each decision. That would raise the upper end of the range to 2.75%, a level not seen since the 2008 financial crisis.
However, even this remains below the expectations of some economists. Citigroup last month forecast hikes of 2.75 percentage points for this year and more in 2023, bringing the benchmark rate to a range of 3.5% to 3.75%.
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original note:
Markets Bet on Sharpest Pace of Fed Tightening Since 1994 (2)
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