The bond market is sending the wrong signals about the US economy

0

LONDON, Feb 24 (Reuters Breakingviews) – Russia’s invasion of Ukraine on Thursday shook financial markets. Through the fog, however, the US bond trade sends the same two messages as before the military onslaught. The first is that there is a growing risk that Federal Reserve Chairman Jerome Powell and his colleagues will raise interest rates so quickly that they tip the US economy into recession. The other is that the US key interest rate will not rise too much above 2% in this economic cycle. Both signals can be erroneous.

The first warning comes from the spread between the benchmark US two-year and 10-year bond yields. This gap has shrunk by two-thirds in three months to stand below 0.4 percentage points and is approaching levels that often serve as an early warning of economic contraction. The second comes from money market prices. They imply that the target federal funds rate, currently at an all-time high of 0-0.25%, will peak at just over 2%. That’s about where it peaked in 2019, but it’s well below the highs policymakers reached in previous cycles.

Neither of the two presumptions can be relied upon. The Fed was slow to react to soaring US annual inflation, which hit a four-decade high of 7.5%. And even policymakers who previously supported a less aggressive stance, like San Francisco Fed President Mary Daly, have recently changed their minds. But pricing managers know that two mistakes won’t cancel each other out. They will be alert to signs of slowing economic growth and ready to slow or hold off on rate hikes.

Join now for FREE unlimited access to Reuters.com

Register

Meanwhile, investors may be overestimating how easily the Fed can pull down US inflation. Some forces that have pushed up consumer prices, such as supply chain disruptions, may dissipate, although a reversal of the recent oil price spike will depend on what happens in Ukraine. Other factors will not go away read more. The longer inflation persists, the more likely it is that wages will rise and price pressures will take root. This would mean more interest rate hikes than markets are currently pricing in.

The additional uncertainty added to the mix by Russian President Vladimir Putin makes forecasting even more difficult than usual. Safe haven Treasuries have suddenly become more attractive. But that doesn’t mean they’re a reliable compass for the future.

Reuters Charts Reuters Charts

To follow @swahapattanaik on Twitter

(The author is a Reuters Breakingviews columnist. The views expressed are her own.)

BACKGROUND NEWS

– Investors piled into US government bonds, sending Treasury yields down sharply, after Russia invaded Ukraine on Feb. 24.

– The yield on the benchmark 10-year Treasury fell 0.15 percentage points to around 1.85% on Feb. 24, while that on the two-year note fell by around the same amount to 1 .46%.

– The spread between two-year and 10-year U.S. government bond yields on Feb. 23 fell below 0.35 percentage points, its lowest level in nearly two years and down from more than 1 percentage point on November 23, 2021.

Join now for FREE unlimited access to Reuters.com

Register

Editing by Richard Beales and Pranav Kiran

Our standards: The Thomson Reuters Trust Principles.

Share.

Comments are closed.