Wednesday's Market Minute: Interest Rate Hikes Look Imminent and Unavoidable

Treasury bonds are one of the trickiest asset classes from which to try and divine the future because they are the most directly affected by interest rate policy. Not only do you have to try and figure out what these instruments are saying about the economic future, you also have to factor in how the Federal Reserve will respond to that future. So you’re predicting two futures: the baseline economic future, and the potential response to that future. I call it the Bond Market Butterfly Effect. It’s like using a word in the definition of that word.

You’ll often hear people make a joke that goes something like this: Treasury yields rose on expectations of economic growth, which increased the odds that higher interest rates will slow the economy, sending yields lower. It’s not a meme; that’s how it works!

That doesn’t mean we shouldn’t try to figure it out anyway.

The Treasury yield curve spent almost the entirety of 2021 flattening: near-term yields rose, and the long end went down. When long yields did go up, the short end went up quicker. This happened because inflation was heating up so quickly that bonds began pricing in tighter policy by the Fed, which threatened the recovery. The strongest evidence for this was in the summer, when Fed Vice Chair Richard Clarida started putting hikes on the table. The dollar and short rates surged, and the yield curve collapsed. An unfavorable tradeoff between growth and inflation kept yields under pressure, and the curve flattened all the way through Powell’s formal resignation of the Fed’s “transitory” paradigm.

Now things are changing a bit. Short-end yields are still rising, but the 10- and 30-years are finally ripping. Combined with Tuesday’s big rally in industrial stocks and banks and the past month’s outperformance of reopening trades over software stocks, this is the signal for healthy growth that Americans should be rooting for. For investors, it’s going to be more complicated.

The market looks to be getting over its fear that higher rates will derail the economy, but that means the odds of the hikes are solidifying. Even uber-dove Neel Kashkari is expecting two. That means the rotation we’ve seen out of expensive growth stocks is likely to continue, and that will make it harder to make money as a passive investor.

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. The content was purely for informational purposes only and not intended to be investing advice.

Image Sourced from Pixabay