The Federal Reserve has made it clear that it wants to raise interest rates to reduce inflation without causing large-scale job losses.
But a rally in the bond market this week shows investors doubting the Fed’s ability to move that needle.
Friday’s session extended a week of falling yields as investors grabbed bonds. US 2-year and 5-year Treasury yields ended the week about 0.30% lower than where they closed last week.
The 10-year U.S. Treasury yield similarly lost about 0.30 percent — falling to 2.79 percent during Friday trading.
As part of its fight to tame inflation, the Fed recently telegraphed that it plans to raise short-term interest rates to around 3.4% by the end of this year — more than double the current limit of 1.6%. The Fed then expects to raise interest rates further in 2023, to around 3.8%.
“The markets are not buying it anymore,” PGIM Fixed Income Chief Economist Ellen Gaske told Yahoo Finance on Thursday.
Gaske said markets suggested the Fed could only raise rates to 3.4% before having to cut rates until next year. Similarly, ING Economics wrote this week that it now expects rate cuts in the second half of 2023.
As the Fed moved toward a more hawkish 0.75 percent move at its June meeting, the yield on the 10-year U.S. Treasury — seen as a proxy for longer-term interest rates — jumped to a post-pandemic high of 3.48 percent. Since then, the picture has changed dramatically as comments from the Fed and other economic data point to stronger recession fears.
Recession now “key case”
On Wednesday, Fed Chairman Jerome Powell admitted there is “no guarantee” the central bank can avoid a hard recession, fueling market fears that the Fed may not follow through on plans to raise interest rates to 3.8 %.
“It’s gotten harder, the trails have narrowed,” Powell said.
Interest rate strategists at BofA Securities wrote on Friday morning that markets are “now moving decisively toward bearish pricing as a base.”
Forecasts from the Federal Reserve Bank of Atlanta this week also showed the US economy would likely have contracted for two consecutive quarters, which some consider the definition of a recession.
On Thursday, the Atlanta Fed’s GDPNow model projected that GDP contracted 1.0% year over year in the second quarter. That forecast was revised to a 2.1% contraction on Friday. The official reading for Q2 GDP is due on July 28.
Powell has signaled that policymakers later this month will likely discuss a rate hike of 0.50% or 0.75% as the central bank approaches estimates of when short-term borrowing costs will be restrictive enough to tame inflation.
Fed officials were confused about this debate. Cleveland Fed President Loretta Mester told CNBC earlier in the week that based on current data, she would support a 0.75% hike. However, Philadelphia Fed President Patrick Harker told Yahoo Finance on June 22 that if the Fed sees household and business demand “softening,” it could support a 0.50 percent hike.
The key will likely be inflation data, where increases in cooling prices may signal a slowdown in demand – something Fed officials would like to see. Government data covering the month of May showed that the pace of year-on-year price increases fell between April and May.
“Inflation can’t come down until it flattens out, and that’s what we’re trying to see,” Powell said on June 15.
The next meeting is scheduled for July 26 and 27.
Brian Cheung is a reporter covering the Fed, finance and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.
Click here for the latest financial news and financial indicators to help you with your investment decisions
Read the latest financial and business news from Yahoo Finance
Download the Yahoo Finance app for apple the Android
Follow Yahoo Finance at Twitter, Facebook, Instagram, Flipboard, LinkedInand YouTube