The Fed had gotten its message across well – there was no upward pressure on bond yields on the day of the FOMC meeting. US yields even fell on the heels of a disappointing inflation figure.
The 25bp key rate hike had already been priced in and almost disappeared from the radar screens, given how focused bond investors are on long duration and low volatility.
Investors seem to be relatively unexposed to Fed moves, as no real surprises are announced and the equilibrium level appears far lower than during previous monetary cycles.
This reversal since the start of the year is due mostly to US investors’ disappointment – disappointment in weaker economic growth, disappointment in low inflation, and more disappointment than ever in US fiscal policy, which is as opaque as it is fickle. Against this backdrop, the markets no longer put much stock in the Fed’s median estimates of their interest rates. And yet…
And yet, the Fed has picked up the pace of its normalisation. It has already hiked four times since bottoming out and is likely to stick to this pace in 2018.
And yet, the Taylor rule says that Fed rates should be 3% higher. And even though domestic inflation is low, hourly wage increases remain above 2.5%. And Janet Yellen is surprised that the Phillips curve is so flat.
And yet, the Fed’s balance sheet of almost 4.5 trillion dollars is likely to shrink steadily, particularly in structured bonds, and relatively fast, based on what Janet Yellen said during her press conference.
Strangely enough, this invisible tightening cycle harkens back to the 2004-2006 cycle and the famous conundrum, which led to an aggressive flattening in the curve and, subsequently, a major credit crunch.
So investors should stay on high alert. For a rate hike is never as invisible as they might think.