Fed’s Higher-for-Longer Mantra Has Doubters in Bond Market

Amid signs the bond market has bought into the Federal Reserve keeping interest rates higher for longer, a cohort of investors is placing bets on the economy hitting a wall — and a sharp policy reversal in short order.

Treasury yields have settled into tight ranges this month near the highest levels in more than a decade as data show a resilient economy and inflation still well above the Fed’s 2% target. But with yields anticipating a peak in the policy rate, the outlook for growth takes on greater importance.

The past week has seen a pickup in demand for options that will turn a profit should interest rates tumble before the middle of next year. That’s a more dire scenario than what’s seen in the swaps market, where traders are no longer pricing in a rate cut during the first half of 2024.

Fed Swaps Show Markets Broadly Aligned with 2024 Fed Forecasts

Bond traders have been placing these sorts of bets since the hiking cycle began and so far they haven’t panned out. But this time may be different as the Fed’s tightening cycle has had more time to work through the economy.

The Fed is widely expected to leave its policy rate unchanged next week after lifting it in July for the 10th time in an aggressive hiking cycle that began in March last year. It’s also seen significantly raising its forecast for growth and indicating another rate increase this year in its so-called dot plot. The rate outlook for 2024 remains up for debate. In June, the median projection showed a full percentage point cut by the end of next year.