(Bloomberg) Unlike their stock market counterparts, Treasury traders don't believe Jerome Powell's optimistic statements about the economy. In fact, an indicator of the bond market began to flash red for the first time since the darkest days of the pandemic.
After the Federal Reserve raised interest rates on Wednesday and pointed to increases at the remaining six meetings this year, part of the Treasury curve — the difference between five- and ten-year yields — was reversed for the first time since March 2020. Meanwhile, the gap between two- and ten-year yields continued to decrease.
These are established indicators of the growth problems that lie ahead as the inflation-fueling repercussions of the Russian invasion of Ukraine continue. With officials projecting that rates will rise to 2.8% by the end of 2023, bond traders are increasingly concerned about the possibility of the economy collapsing under the weight of monetary policy normalization.
“The market is discounting a higher risk of recession and that can be seen with investment between five and ten year yields,” said Andrzej Skiba, head of US fixed income for RBC Global Asset Management. “The Fed is sending a strong commitment to combat inflation.”
At a meeting considered hard-line on many fronts, Fed President Jerome Powell reiterated that the central bank is keeping all options on the table to fight the highest rate of inflation in decades. In turn, traders pushed two-year performance to a new cycle high, just below 2%, and at one point discounted a probability of more than three out of four of a 50 basis point increase in May.
All this makes it clear that the volatile changes that have marked the negotiation of fixed income this year are not going to disappear anytime soon.
While equity traders took comfort in the Fed's firm decision to restore price stability, bond investors — who are already grappling with the worst performance of the Bloomberg Treasury index in decades — are preparing for further losses.
“It's as if Powell wants to sound optimistic, but, at the same time, tough on inflation, without pointing out that this will ultimately end with a policy error and a risk of recession at the back end,” said George Goncalves, head of macro strategy for the US at MUFG. “Time will tell.”
The Fed's projections of aggressive increases were seen by some as an admission that policy has proven to lag far behind given high inflation. At the same time, at the press conference that followed the rate decision, Powell's aggressive signals also posed a challenge for those in the bond market who had expected a more moderate pace of tightening, given the uncertain global economic context.
Powell downplayed the risk of a recession in the US next year, stating that monetary policy can be toughened without sacrificing economic growth.
Original Note:
Bond Traders Stunned by Hawkish Fed Are Sounding Growth Alarm
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