The final kicker is the Fed’s lack of forward guidance that more rate hikes are imminent. While there is much debate about how hawkish this signal is, it has been taken as some kind of sign that the Fed will be guided by the data from here.
Support for cuts
Markets are currently looking beyond rapid rate hikes and attempting to time when central banks will cut interest rates.
In Australia, short-term money markets had until recently been expecting the Reserve Bank to raise interest rates aggressively this year and next, on the expectation that the policy rate would settle above 4 per cent around May or June 2023.
But now the market expects the Reserve Bank to be largely done with rate hikes by the end of the year. The market implied cash rate is 3.44 percent in February and is expected to remain flat thereafter.
Short-term money markets in the US also expect the Fed to end its rate-hike cycle as early as December, when the Fed’s interest rate is expected to hit 3.32 percent. A decline to 2.81 percent is forecast by the following year.
So the market is saying cuts are coming next year. An inverted or negatively sloped yield curve is a source of great concern as it is seen as a harbinger of a recession. In the US, the two-year yield of about 3 percent is below the 10-year yield of 2.8 percent.
What is striking about Australia’s yield curve, however, is that it is still positively sloping. The 10-year rate of 3.2 percent is still above the two-year rate of 2.7 percent.
That’s largely because the Reserve Bank is lagging behind other central banks in raising interest rates, according to RBC Capital Markets.
The Bank of Canada, for example, raised interest rates by 1 percent at its last meeting and has a yield curve similar to that of the US. But it’s only a matter of time, they say, before the Reserve Bank catches up with its peers and reverses the bond curve.
The inversion was supported by strong downward moves in long-term bond rates, suggesting that the economy will slow and inflation will cool off in the long-term.
10-year interest rates in most markets are either slightly above or within central bank inflation targets.
If long-term interest rates remain low and stable, that will be good news for all speculators who have another six months to endure the pain caused by bond markets. But by now they should be aware of the risks of underestimating inflation and the resulting punishment.
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