(Bloomberg) - The U.S. bond market stands on the cusp of pricing in the prospect of the most aggressive rate hike seen from the Federal Reserve in nearly three decades.
For the first time this year, traders are pricing in a near-equal chance that Fed policy makers in June will raise their benchmark rate by 75 basis points, following the half-point move that’s expected at their meeting next week. The Fed hasn’t done a 75-basis-point increase since 1994, toward the end of a path from 3% to 6%. The current level is a band of 0.25%-0.5%, after a quarter-point increase from rock-bottom in March.
Swap contracts for June were pricing in about 111 basis points of tightening, 11 basis points beyond the full percentage point of hikes already expected in May and June combined. Earlier this week, 106 basis points were priced in.
While a three-quarter-point rate increase “is in their tool kit and they have done it before,” three straight half-point moves remains the more likely course judging by most Fed officials’ recent comments, said Gregory Faranello, head of U.S. rates trading and strategy for AmeriVet Securities. “They will need to balance out the pace of rate hikes if they want a soft landing” for the economy.
Elevated inflation pressure suggesting the central bank is behind the curve has prompted traders to expect half-point hikes at each of its next four scheduled policy meetings, beginning with the May 3-4 confab. The market-implied peak rate is 3.30% by the middle of 2023, beyond the Fed’s own forecast of 2.8%.
The pricing in of aggressive Fed action has put upward pressure on U.S. Treasury debt yields, creating historic losses for investors. Treasuries have lost 2.7% this month through Thursday, extending their year-to-date slide to 8%.
U.S. two-year yields jumped as much as 14 basis points to 2.755% Friday and are poised for their ninth straight monthly increase, the longest stretch in Bloomberg data going back to 1976. Yields on 10-year notes rose as much as 11 basis points, before some relief in anticipation that month-end index rebalancing would create demand for bonds. Treasury yields were just shy of their session highs late in New York trading as equities tumbled sharply to end the month, with the S&P 500 closing 3.6% lower.
The move higher in Treasury yields was sparked by data showing a record 1.4% first-quarter increase in the Labor Department’s employment cost index, a broad gauge of wages and benefits. Separately, the personal consumption expenditures price index, the Fed’s preferred measure of inflation, advanced 6.6% from March 2021, the most since 1982.
The employment cost data are “adding to the wage-price spiral narrative as increased spending capacity fuels the inflationary narrative,” Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, said in a note. “Given the emphasis on wages at this point, it was ultimately the ECI figures that drove the market’s response.”
The bond market’s implied inflation expectations remain elevated, with 10-year breakeven rate for inflation-protected debt hovering around 3%, near the record high reached this month.
Yields retreated from session highs after the U.S. April MNI Chicago Business Activity index fell more than forecast to 56.4, close to the lowest level of the past year.
“At some point, they may need to do 75bps or 100bps,” said Ed Al-Hussainy, senior interest-rate strategist at Columbia Threadneedle Investments. “But right now, let’s set the pace at 50 for the next three, four meetings to get it to neutral and then reassess. There’s no reason to break anything. The market has done a lot of work for the Fed.”
(Adds trader and investor comments, plus bond market performance, beginning in fourth paragraph.)
By Michael MacKenzie, Edward Bolingbroke and Ye Xie
