The Bond Market Isn’t Buying Fed’s Sketch of Rate Hike Plans

Bond traders suspect the Federal Reserve will quickly discover it’s being too ambitious with its newly hawkish stance.

The Federal Open Market Committee just forecast overnight rates jumping from zero currently to 1.60% and 2.10% by year-end 2023 and 2024, respectively. Traders see it differently, with eurodollar futures contracts pricing in 1.50% short-term rates on both dates.

The concern is that the economy won’t be able to handle the loftier rates policy makers have in mind, which limits how far central bankers can raise interest rates and how high Treasury yields can go.

“There is an elevated risk of a policy mistake,” said Dan Ivascyn, chief investment officer at Pacific Investment Management Co., which has $2.2 trillion of assets. “The Fed is in a difficult position.” There’s a risk “inflation stays higher for longer” than many expect, he added.

Fed Dot Plot Offers Clues on Pace of Fed Funds Change (Table)

The yield on the U.S. 30-year Treasury bond has fallen to around 1.81% from this year’s peak of 2.51% in March, while the 10-year is at 1.40%. Long-term yields have come down as traders priced in the start of what they see as a quick-yet-shallow cycle of Fed rate increases. As a result, the gap between 5- and 30-year yields has plunged to 63 basis points from a multi-year high of 167 basis points in February.