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U.S. Treasury Market is Pricing in Steeper Rate Hikes, Should You? 

  • U.S. Federal Reserve rhetoric becomes progressively more hawkish, hinting at far more aggressive rate hikes and Treasury markets are pricing that in 
  • Equity markets remain relatively sanguine about rate hikes, with stocks posting their second consecutive week of gains 

 

Forget about the posturing by central bankers as to where interest rates are headed to next, what matters is whether or not investors believe them.

And right now, it appears that the market believes the U.S. Federal Reserve will get far more serious on rate hikes than expected, prompting a massive selloff in U.S. Treasuries into the weekend.

The yields on the benchmark U.S. 10-year Treasury Note soared to 2.479% on Friday, the highest since May 2019 (yields rise when bond prices fall).

Treasury yields affect the cost of everything from mortgages to student loans not just in the United States, but across the entire world at a time when inflation and growth are not occurring in a uniform manner globally.

Yields have soared in the past week as top U.S. central bankers echoed U.S. Federal Reserve Chairman Jerome Powell’s recent comments that the Fed would need to step up its tightening of monetary policy.

That has raised the specter of a 0.50% rate hike at the Fed’s next rate-setting meeting.

But expectation of rate hikes don’t typically affect yields in isolation, higher borrowing costs usually serve as a headwind for risk assets as well and thus far, there’s no indication that equity markets are pricing in such an aggressive pace of tightening.

Into the weekend, major indices in the U.S. and Europe notched gains, albeit modest ones, although the more rate-sensitive tech sector did mark a slight decline.

Part of the reason of course is the lack of liquidity in Treasury markets, leading to outsized shifts in yield – there just isn’t a whole bunch of volume to cater for large trade sizes without moving the market.

That lack of liquidity is leading to more visceral swings in Treasury yields and that’s why for now at least, the equity markets haven’t responded in like manner.

While the Fed has communicated a more hawkish turn, even to the point of potentially becoming punitive, the reality is that it’s just too early to call right now.

The prospect of peace in Ukraine is increasing as Moscow is finding itself bogged down and appears to be in a face-saving move to redefine its victory conditions to just the eastern portions of Ukraine which it’s occupied for almost a decade now.

That could potentially pave the way for peace in Ukraine, rebuilding, and a return of the country’s supply of essential food crops such as wheat and sunflower oil.

But even if peace is wrought in Ukraine, the West hasn’t laid down the necessary preconditions for Russia to return to the market with its natural gas and oil – a factor which is continuing to put pressure on prices and stoke the fires of inflation.

Looking at equities last week, it appears that investors aren’t necessarily betting that the Fed is likely to strangle markets, with both the Nasdaq Composite and S&P 500 recording their second consecutive week of gains.

The Treasury markets may tell one story, but it’s hardly the entire one. 

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