Money market traders are betting the Federal Reserve is headed for its most aggressive monetary policy in nearly three decades as it battles a rise in commodity-driven inflation.
In mid-March, in the midst of a scenario of a sharp increase in inflation in the United States, which in February rose 0.8%, raising the annual record to 7.9%, the highest in 40 years, and with price pressures that have been exacerbated by the war between Russia and Ukraine, The Federal Reserve (Fed) applied its first interest rate hike since the end of 2018.
Now traders are eyeing another 225 basis points of interest rate hikes by the end of the year, on top of the 25 basis points already implemented last month.
The Fed hasn’t tightened that much (250 basis points) in a year since 1994, a year famously brutal to bond investors that even included a 75 basis point hike.
The last year of more tightening was in the early 1980s, when Paul Volcker was in charge of the central bank.
© Samuel Corum
Jerome Powell, Fed Chairman
Impact on bonds
The prospect of aggressive tightening has already led to a global bond slump this year, with the latest move in market bets following 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 it also doesn’t want to be constantly changing the pace of tightening, he added.
Ostwald expects a half-point increase next month and probably in June, followed by quarter-point increases.
US Treasuries fell for the fourth day in a row on Wednesday, sending the yield on 10-year notes up 10 basis points to a three-year high of 2.65%.
That followed Tuesday’s advance that was the highest 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 just 3%, the highest since 2015.
As the inflationary backdrop worsens, Fed Chairman Jerome Powell and several other policymakers have indicated they are willing to raise US rates in 50 basis point increments if necessary.
With six meetings remaining this year, the current level would equate to three half-point hikes and three quarter-point hikes, 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 Inc. last month forecast a 2.75 percentage point increase this year and more in 2023, bringing the benchmark rate to a range of 3.5% to 3.75%.