Bond investors like short maturities and are wary, even when the Fed threatens small rate hikes


NEW YORK, Oct 31 (Reuters) – Many bond investors are playing it safe at the short end of the yield curve, even as Federal Reserve officials started to float the idea of ​​smaller rate hikes as early as the December monetary policy meeting.

Investors are broadly expecting the Fed to hike its federal funds rate benchmark by 75 basis points to a range of 3.75% to 4.00% this week, marking the fourth consecutive outsized hike. For December, however, the futures market has discounted a 68% chance of a 50 basis point gain for Fed funds after Fed officials hinted at a potential slowdown in the pace of tightening.

“In our view, the Fed will continue to tighten policy through 2023. We expect price pressures to be well beyond their mandate and to continue into 2023,” said Tom Hainlin, national investment strategist at US Bank Wealth Management in Minneapolis.

“If we think inflation is a bit more persistent and the Fed needs to be aggressive, we still prefer to be on the shorter end of the curve,” he added.

In an environment of rising interest rates, bond investors tend to reduce the duration of their portfolios. The longer the duration, the higher the losses when interest rates rise.

The Federal Open Market Committee meets Tuesday and Wednesday and will release its decision and policy statement Wednesday at 2:00 p.m. EDT (1800 GMT).

US Financial Conditions (FCI), which typically include borrowing costs, equity levels and exchange rates, eased over the past week as stock prices rallied, according to Refinitiv data. But conditions are much tighter than they were a year ago, before the Fed began raising rates for 2022.

get tight

Just two weeks ago, before the communications blackout before each Fed meeting, St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari, both widely regarded as political hawks favoring aggressive tightening, bid to end the worst inflation since four decades stressed the need to end rate hikes in early 2023.

In separate comments, San Francisco Fed President Mary Daly said “now is the time to start talking about resigning.”

Analysts said a slowdown in the tightening process will allow the impact of the rate hikes to be felt in the economy. The problem, however, is that the market sees this move lower as a prelude to rate cuts, which many believe is not the case at all.

Tiffany Wilding, North American economist at PIMCO, said the challenge for the Fed, which is likely to prepare the market for a pause in tightening, is not just brokering that pause while price pressures remain elevated, but also getting the message across from the Fed strengthening remains focused on bringing down inflation.

“And … it won’t move quickly to falling interest rates given the likely increasingly weak economic activity,” Wilding wrote in a research note.


Equally important are the language and nuances in the policy statement and what Chairman Jerome Powell says at the press conference following its release.

Zachary Hill, head of portfolio management at Horizon Investments in Charlotte, North Carolina, noted that when Powell refers to a change in the pace of aggressive tightening, he will emphasize that it does not represent monetary easing.

“It simply represents a change in the pace of tightening to assess the impact of a record tightening cycle on the real economy,” he said

Similar to Bank of America’s Hainlin, Hill believes inflation will remain stubbornly high, citing companies, particularly those that sell consumer staples, as aggressively raising prices.

However, Hill pointed out that short-term rates are well above long-term neutral levels and said it makes sense to add a bit more duration exposure.

“But we’re not going to load the boat now. We must be careful not to become overly optimistic about changing the course of Fed policy.”

Certainly, while still cautious, some bond market participants could not ignore the rise in US yields, which has added value to longer-duration bonds.

Since the beginning of August, benchmark 10-year government bond yields have risen by about 148 basis points. The yield hit a 15-year high of 4.338% on Oct. 21.

“The likelihood of the Fed slowing the pace of rate hikes early next year has increased, suggesting that most of the overall rise in yields this cycle has already happened,” said Chip Hughey, managing director, fixed income, at Truist Advisory Services in Richmond, Virginia.

He recommended adding duration to bond portfolios. Hughey pointed out that high-quality, long-duration fixed income securities like Treasuries are better able to offer portfolio protection and more attractive income levels for investors.

Reporting by Gertrude Chavez-Dreyfuss in New York Graphics by Saqib Iqbal Ahmed Editing by Alden Bentley and Matthew Lewis

Our standards: The Thomson Reuters Trust Principles.


Comments are closed.