History Says Bond Traders Are Terrible at Timing Fed Liftoff

A word of warning for all those bond traders banking on a Federal Reserve rate hike as soon as next year: Since 2008, markets have underestimated how patient officials can be in lifting borrowing costs from zero.

After the Fed first slashed rates that low during the financial crisis, hedgers and bettors in money-market derivatives established a track record of being consistently too aggressive on a first move higher, according to JPMorgan Chase & Co. In late 2008, traders already saw several hikes in the following couple years, even though it ultimately took officials until 2015 to tighten, the bank’s analysis shows.

That pattern may be happening again -- the savviest speculators in interest rates are looking at trillions of dollars in stimulus and an accelerating vaccination campaign and they’re concluding that there’s no way rates can stay this low without inflation getting out of control.

Swaps and futures now reflect almost a quarter-point of tightening late next year, and fully price in three increases of that size in total by the end of 2023.

To be clear, the Fed hasn’t always stuck with its plans for the path of rates. But Wall Street strategists warn that the likely outcome this time is that the market ultimately blinks first. It’s a game of chicken that carries risk for both sides, not just traders with money on the table.

For the Fed, the standoff threatens to complicate its entire policy framework. The peril is that its message of patience will continue driving up long-term Treasury yields, already near the highest in more than a year, and eventually tighten financial conditions by rattling stocks or jacking up corporate financing costs.