Bond market zooms ahead of Fed on rate hikes
The bond market went nuts Thursday, sending interest rates surging. But the market looks to have gotten ahead of itself.
Why it matters: The extraordinary run-up in rates makes sense if you believe the Federal Reserve is going to react to the somewhat-higher-than-expected January inflation figures with a sense of panic. But that's not the pattern the central bank's leaders, and particularly chair Jerome Powell, have displayed throughout the last year — so the shift in expectations looks to be overblown.
- Fed policy leaders are near-certain to raise the target interest rate next month, but it's still no sure thing thing they'll move as aggressively as markets now expect — and unlikely they'd move before their regularly scheduled meeting, as some market chatter discussed Thursday.
State of play: The yield on two-year Treasury securities rose an extraordinary 0.24 percentage points Thursday, to 1.58%. Futures markets now price in a near-certainty that the Fed will raise rates a half percentage point next month, which would be the first such move in two decades.
- The swing was driven initially by a Consumer Price Index report for January showing 0.6% inflation, higher than the 0.4% expected, and the highest year-over-year number (7.5%) in four decades.
- Later in the day, James Bullard, president of the Federal Reserve Bank of St. Louis, told Bloomberg that he favors raising rates half a percent at the March meeting and a full percentage point by July.
The big picture: It is true that the hot inflation number tilts the Fed toward more aggressive monetary tightening. But it was not so far out of the range of expectations that Fed leaders would be likely to toss out their playbook as dramatically as the market moves suggest.
- Bullard has a vote on monetary policy this year, but historically his policy views have been more reactive to the latest data point than the typical Fed official, and certainly more so than Powell and other core leaders.
- The inflation numbers overshooting expectations by two-tenths of a percentage point for a single month are not enough to radically change those views.
Powell and his colleagues have been pushing toward higher rates in a gradual, step-by-step process, keeping options open and aiming to tighten financial conditions without breaking the economy.
- They're more likely to be open to large, abrupt interest rate hikes only after the rate-rising campaign has begun and it's clearer whether inflationary pressures are subsiding or not.
The bottom line: Fed leaders are loath to seem panicky, and believe that moving too abruptly could introduce unhelpful volatility to markets and the economy. Based on that mindset, a single month's CPI reading won't be enough to radically change the trajectory of policy — even if it created a hairy day in the markets.