US economy

Hawkish forecasts jolt Treasury market


Treasury yields surged and US stocks slipped after policymakers at the Federal Reserve signalled that they expected to lift interest rates in 2023, a year earlier than previously thought.

The yield on the benchmark 10-year Treasury note rose 0.09 per cent to 1.58 per cent following the decision from the US central bank and comments from Fed chair Jay Powell, who struck an upbeat tone about the US economic recovery while also acknowledging the risk of higher inflation.

Among shorter-dated government bonds most sensitive to interest rate policy, there were even larger moves. The yield on the five-year note climbed 0.12 percentage points to 0.895 per cent — its largest one-day gain in almost four months — while the yield on the two-year note hit its highest level in a year at 0.2 per cent.

The equity market slid alongside the rise in Treasury yields, with the blue-chip S&P 500 declining 0.5 per cent and the technology-heavy Nasdaq Composite sliding 0.2 per cent.

Line chart of Yield on the five-year Treasury note (%) showing Fed decision jolts $21tn US Treasury market

“Just as the market was getting comfortable with a patient Fed and inflation considerably above target, the dot plot has shifted,” said Seema Shah, the chief strategist of Principal Global Investors, referring to the graph showing Fed officials’ interest rate predictions.

“Now it will be up to Powell and other Fed speakers to once again reassure markets that tightening in 2023 doesn’t need to be disruptive.”

The equity market rally over the past year has been in part predicated on rock-bottom interest rates, which the Fed has anchored near zero since the crisis began in March last year.

Accompanying the signal from policymakers at the US central bank that they could raise rates sooner than previously thought, Powell also acknowledged that the Fed was now “talking-about-talking-about” tapering the Fed’s $120bn-a-month asset buying programme, which investors expect will soon happen.

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Markets have worried that signs of higher inflation, which Fed policymakers acknowledged in their economic projections published on Wednesday, could force the central bank’s hand.

“In the past six months there has been a significant change in where Fed policy is heading in terms of an exit strategy,” said Kevin Flangan, head of fixed income strategy at WisdomTree. “This was a meeting that created a stir in the bond market and it provided a little bit of a snapshot of what investors can expect during the second half of the year.”

Aneta Markowska, an economist with Jefferies, added that the comments Powell were “a much more hawkish outcome” than the market had anticipated.

“After dismissing rising inflation and inflation expectations for the past three months and focusing solely on the labour market, it feels like the Federal Open Market Committee just put its hands back on the wheel,” she said.

Traders dialled back their expectations for higher inflation as a result. The 10-year break-even rate fell 0.06 percentage points to 2.32 per cent.

The US dollar index climbed 0.8 per cent along with the uptick in Treasury yields. The pound fell 0.6 per cent against the dollar, while the euro slipped 1 per cent to $1.20.

European stocks finished at new records before the release of the Fed decision. The Stoxx Europe closed up 0.2 per cent for another all-time peak, the region-wide benchmark’s ninth session of back-to-back rises.

Frankfurt’s Xetra Dax rose 0.1 per cent, while both the CAC 40 in Paris and London’s FTSE 100 climbed 0.2 per cent.

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Additional reporting by Michael Mackenzie in New York and Siddharth Venkataramakrishnan in London

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