Bond traders sound alarm bells on post-Fed growth

Unlike their stock market counterparts, Treasury traders don’t believe Jerome Powell’s upbeat statements about the economy. In fact, a bond market indicator began flashing red for the first time since the darkest days of the pandemic.

After the Federal Reserve raised interest rates on Wednesday and pointed to hikes at the remaining six meetings this year, part of the Treasury curve — the difference between five-year and 10-year yields — inverted for the first time. since March 2020. Meanwhile, the difference between the two-year and ten-year yields continued to narrow.

These are time-honored indicators of looming growth woes as the fallout from the Russian invasion of Ukraine continues to fuel inflation. With officials projecting rates will rise as high as 2.8% by the end of 2023, bond traders are increasingly concerned that the economy could collapse under the weight of monetary policy normalization.

“The market is pricing in higher recession risk and you can see that with the investment between five and ten year yields.said Andrzej Skiba, head of US fixed income at RBC Global Asset Management. “The Fed is sending a strong commitment to fight inflation.”

In a meeting seen as hard-line on many fronts, Fed Chairman Jerome Powell reiterated that the central bank kept all options on the table to fight the highest rate of inflation in decades.

In turn, traders pushed the two-year yield to a new cycle high, just below 2%, at one point pricing in a more than three-in-four chance of a 50 basis point rise in May.

All of this makes it clear that the volatile swings that have marked fixed income trading this year are not going to go away any time soon.

While stock traders took comfort in the Fed’s ironclad decision to restore price stability, bond investors — already grappling with the worst performance of the Bloomberg Treasury Index in decades — are bracing for further losses. .

“It is as if Powell wants to sound optimistic but, at the same time, tough on inflation, failing to point out that this will ultimately end with a policy error and recession risk on the back end.said George Goncalves, MUFG’s head of US macro strategy. “Time will tell”.

The Fed’s aggressive hike projections were seen by some as an admission that policy has proven far behind given high inflation.

At the same time, in the press conference that followed the rate decision, Powell’s hawkish signals also posed a challenge to those in the bond market who had expected a more moderate pace of tightening given the uncertain global economic backdrop.

Powell downplayed the risk of a US recession next year, saying monetary policy can be tightened without sacrificing economic growth.