The bond market resumed pricing in better-than-even odds of a Federal Reserve rate hike next week, reversing much of Monday’s collapse in yields that was fueled by bets that a spate of bank failures would stay the central bank’s hand.
(Bloomberg) — The bond market resumed pricing in better-than-even odds of a Federal Reserve rate hike next week, reversing much of Monday’s collapse in yields that was fueled by bets that a spate of bank failures would stay the central bank’s hand.
The repricing was underway before the release of February inflation data that was mostly in line with expectations, and the data had little immediate effect. The two-year Treasury rate, which tumbled 61 basis points on Monday, was up 21 basis points at 4.19% late in New York. Trading remained volatile during the session as the benchmark reached a high near 4.4%.
Swap traders upgraded the chances of a Fed rate hike next week to around 80% from roughly 50% at Monday’s close. Those odds only briefly edged higher after the core consumer price index rose slightly more than economists estimated, while still showing slower annualized rates compared with January.
The inflation data, “should add to the probability of a 25 basis point hike in March, but only at margins,” said Alan Ruskin, chief international strategist at Deutsche Bank.
The Treasury market in the past week has undergone a seismic shift, with two-year yields reaching a multi-year high of 5.08% on Wednesday after Fed Chair Jerome Powell said he was open to re-accelerating the pace of rate hike’s from January’s quarter-point increase if warranted by economic data.
“The Fed, which just last week had a singular focus on its price stability mandate, now sits between a rock and a hard place in trying to balance inflation and financial stability risks,” Jason Pride, chief investment officer of Private Wealth at Glenmede, wrote in a note Tuesday. “While opinions vary greatly on the matter, a rate hike of 25 basis points remains on the table next week.”
The two-year yield dipped below 4% Monday as investors dumped US bank shares despite a rescue plan announced by regulators late Sunday, and it touched 3.82% in early European trading, breaching its 200-day moving average for the first time since mid-2021. Financial stocks rebounded Tuesday.
The financial turmoil spurred several Wall Street banks to change their forecasts for next week’s Fed meeting. Goldman Sachs, NatWest Markets and Barclays dropped calls for a March rate hike, while Nomura Securities predicted a rate cut next week.
Meanwhile inflation continues to run much hotter than the Fed’s 2% target rate. The consumer price index rose 6% year-on-year in February, down from 6.4% in January. The core CPI eased to 5.5% from 5.6% despite rising 0.5% for the month.
“Our view is that ultimately the ring fencing works and the Fed goes back to hiking interest rates,” Ethan Harris, head of global economics research at Bank of America Corp. said on Bloomberg television, referring to the regulatory response to the bank failures. “Ultimately the Fed is going to end up having to fight inflation.”
–With assistance from Liz Capo McCormick.
(Updates yield levels, adds forecasts for March Fed meeting)
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