UOB Kay Hian Bond Radar
US inflation is near its peak? The US Federal Reserve (Fed) hiked interest rates by 75 basis points to a target range of 1.5 – 1.75% on 15 June. This is the biggest rate hike since 1994 and the third hike this year.
FED is dealing with 3 problems at the same time with 1 tool (interest rate):
- Inflation is on fire;
- Potential recession and drop in the employment rate;
- A falling US stock market.
Can Fed tame inflation without triggering a recession?
To fight inflation, FED would increase interest rates while trying its best to avoid a hard landing to cause a recession. The bears think the Fed's plan to stop inflation is basically to start a recession that throws people out of work and therefore caps wages and reduces demand. Bonds and stocks are falling and investors are frightened. The stock market is not the FED's primary concern but Wall Street has a significant influence on Washington. Washington then puts pressure on the FED. It feels like the US FED is playing block tower and pulling the wrong piece will end up in a hornet's nest.
CME website has a CME FedWatch Tool that shows the latest probabilities of FOMC rate implied from its futures market. As of 23 June, the futures market was indicating Sep 2022 FED rate hike would take the upper band to 3.00% and it would still be above 3% looking at July 2023 futures contract. The peak is expected to be the most probable at 3.50-3.75% in March 2023 and May 2023 estimated FED meetings. In June 2023 FED meeting, the probability of the FED rate to be at 3.25-3.50% is at 31.6%, and 3.50-3.75% is at 30.6%. The most probable FED rate in July 2023 is 3.25-3.50%.
If Fed can tame inflation without going above the 4% rate, the market feels that is a soft landing and US can escape recession. Rates will fall when growth declines. Growth is the biggest driver of longer-dated bond yields. When the bond market believes in this tune, we will see some risk-on appetite for longer-dated bonds (>10 years maturity).