Fed rate hikes could climb further than markets expect, according to T. Rowe Price Capital Markets Strategist Tim Murray.
Key Takeaways:
- Futures markets priced in just over four Fed hikes through 2027 after the Sept. 16 increase.
- A rising term premium, not Fed policy alone, drove most of the 10-year Treasury yield’s two-year climb.
- TBUX holds short-term investment-grade debt and had a 5.19% yield to maturity as of Sept. 30.
The Federal Reserve raised its target range by a quarter point on Sept. 16, its first hike since 2023. In a recent report, Murray wrote that “the easing cycle is over, and the burden of proof has flipped.”
Futures markets see a gentler path. As of Sept. 23, they priced in just over four quarter-point hikes through the end of 2027, with almost two coming by year-end, according to the report.
History points the other way. Since 1994, five of six Fed hiking cycles have lifted the federal funds rate at least 175 basis points from its starting point, Murray wrote. That record suggests bond investors could face higher rates than current pricing implies.
Murray also argued that the Fed has become a smaller driver of longer-term Treasury yields. The 10-year yield rose from about 3.73% to 5.1% in the two years ended Sept. 23.
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Only about 72 basis points of that jump came from higher expectations for Fed policy, according to the report. The rest reflects a higher term premium, or the extra yield investors want for holding longer-term bonds.
Murray linked the premium to geopolitical uncertainty, persistent inflation concerns, heavy Treasury issuance, and expected growth in global capital spending. Those pressures could keep pushing long-term yields higher even if the Fed’s hikes stay modest.
Fed Outlook Leaves Little Reward for Longer Bonds
Investors also aren’t earning much for taking that risk. As of Sept. 23, the two-year Treasury yielded 4.85%, according to T. Rowe Price. The 10-year paid 5.1%, while the 30-year paid 5.4%.
That means just 25 extra basis points for stretching from two years to 10, Murray wrote. With so little extra pay, the firm’s Asset Allocation Committee is sticking with a short duration stance in fixed income.
Short-term bonds are the focus of the T. Rowe Price Ultra Short-Term Bond ETF (TBUX). The actively managed fund aims to offer higher income potential than traditional cash investments, according to T. Rowe Price.
As of Sept. 30, the fund had a 5.19% yield to maturity and a 4.67% 30-day SEC yield, T. Rowe Price said. It launched in September 2021 and charges a 0.17% expense ratio. The ETF held $1.9 billion in net assets as of Oct. 16.
TBUX holds high-quality debt such as investment-grade corporate bonds and securitized bonds, which are backed by pools of loans, the firm said. Its portfolio pairs a cash buffer for liquidity with a core of income-focused holdings. It also uses a maturity ladder, or bonds coming due on staggered dates, to supply new cash to invest.
How far the Fed goes will help determine what that cash earns. Even the market’s milder outlook implies more hikes ahead. Bloomberg data in Murray’s report show the futures-implied fed funds rate rising from 3.75% in September to 4.18% by December and 4.77% by the end of 2027.
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Originally posted on ETF Trends
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