Higher for longer? What's that, asks the Fed
The US 10-year bond yield has seen significant movement in the 4.5-4.9% range over the past two months. Some investors expected the Federal Reserve to begin easing monetary policy sooner on growth concerns, and were thus bidding up bond prices, causing yields to fall. At the other end, consistent pressure on the US fiscal deficit and a lack of faith in the Fed’s easing was putting upward pressure on yields.
The dam broke towards falling yields in the past week, especially after the Fed’s December policy announcement. In the developed world, inflation was so far above its near-term average that central banks had to respond aggressively in 2022 and take rates back to levels not seen in the past 15 years. Given repeated supply shocks and stimulus-induced demand growth, the central banks also feared that inflation would remain high and thus continued their rate hikes in 2023.
The Federal Reserve has paused hikes since September, with the Fed funds rate at 5.25-5.5%. The September dot plots and economic projections showed that the Federal Open Market Committee (FOMC) was expected to keep rates around the same level in 2024. All that has changed with the December statement.
The FOMC now seems confident of keeping inflation around 3% with a slightly weaker economy and higher unemployment. This means that a majority of Fed governors now expect the FOMC to cut rates in 2024. The bond market reacted sharply.
The US 10-year bond yield is now below 4%. The two-year treasury yield (which is more sensitive to the Fed funds rate) has fallen from 5.2% in October to around 4.4% at the time of writing this. That is incredible movement at a time when the headline consumer price index (CPI) is only expected to ease by about 30-40 basis
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