(Bloomberg) Unlike the stock market, Treasury traders do not believe Jerome Powell's optimistic statements about the economy. In fact, the indicators in the bond market began to flash red for the first time since the darkest day of the pandemic.
Part of the Treasury curve (the difference between 5-year and 10-year yields) reversed for the first time since March 2020, after the Federal Reserve raised interest rates on Wednesday and pointed to the increase in the remaining six meetings this year. Meanwhile, the gap between 2-year and 10-year yields continued to decline.
This is an established indicator of future growth issues as the inflationary fuel impact from Russia's invasion of Ukraine continues. As officials expect interest rates to rise to 2.8% by the end of 2023, bond traders are increasingly concerned about the possible collapse of the economy under the weight of normalizing monetary policy.
“The market has a higher risk of recession and can be seen as an investment between 5 and 10 years,” said Andrzej Skiba, head of US fixed income at RBC Global Asset Management. “The Fed is making a strong commitment to fight inflation.”
Fed President Jerome Powell reiterated at a meeting considered difficult on several fronts that the central bank was keeping all options on the table to fight the highest inflation rate for decades. As a result, traders raised their 2-year performance to a new cycle high just below 2% and discounted the odds of 3 or more out of 4 of the 50 basis points increase in May.
All this makes it clear that the change in volatility, which symbolizes fixed income negotiations this year, will not disappear sooner or later.
Stock traders have been comforted by the Fed's firm decision to restore price stability, but bond investors who have already been struggling with the worst performance of the Bloomberg Treasury index for decades are preparing for further losses.
George Goncalves, head of US macrostrategy at MUFG, said: “I want Powell to sound optimistic, but at the same time, it's tough on inflation, and I struggle with inflation without pointing out that it will ultimately end up with policy errors and risk of a recession in the backend. “Time will tell.”
The Fed's aggressive growth outlook was seen as an acknowledgement that the policy proved to be far behind given the high inflation. At the same time, Powell's aggressive signal at a press conference following the interest rate decision posed a challenge for bond market people who expected a more modest tightening rate given the uncertain global economic situation.
Powell downplayed the risk of a recession in the United States next year, saying that monetary policy could be strengthened without sacrificing economic growth.
Original note:
Bond traders who have been knocked out by hawkish Fed are sounding growth alarm
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