Terminal Rate Rises and Market Expectations Shift: High Beta Fixed-Income Markets Reap the Benefits
The terminal rate has gone up to 3.56% from its original 3.44%, and the market's anticipation of further policy loosening has decreased to less than 90bp from the highest interest rate until 2024. Since December, real rates as a measure of financial conditions have been at the higher end of their recent range. Our economists have forecasted the possibility that, following the month of March, the European Central Bank (ECB) may increase the deposit facility rate by 25 basis points at each meeting through June, which would bring the rate to 3.5%. The market has gone even further, however, the US's developments have aided the hawks and it is unlikely they would have been able to achieve the same success without them.
High beta fixed-income markets, unlike those with higher ratings, are still having a moment of glory. In stark opposition to this, stocks fell and credit spreads increased in 2022 due to expectations of a tighter monetary policy. It is the correct type of tightening to increase the core rates in response to the improved growth outlook, in theory. Lorie Logan of the Dallas Fed has suggested that interest rates may need to go up in order to respond to any changes in the economic outlook or to counteract any unwanted loosening of financing conditions. The Federal Reserve would raise interest rates in order to reduce economic growth and/or control financial markets. It appears as though Goldilocks has been shouldering the burden of the market's sentiment since the beginning of the year.
The remarks of theirs correlated with a US January PPI release that exceeded expectations, consequently pushing 10-year US Treasury yields up by an additional 6-7 basis points. At 3.89%, the US 10-year yield is now the highest since November. The higher rates for longer thesis has also seen some substantial re-pricing of the Fed curve this month where market pricing for the December 2023 Fed Funds rate has risen to 5.10% from 4.35%. Two weeks ago, markets predicted one rate hike and two cuts this year; however, the shift has been considerable and now there is the potential for four hikes this year. In a period of only two weeks, the 2-year Treasury yield in the United States has increased from 4.1% The 10-year rate has risen to 3.9%, its highest since November, after beginning February at 3.4%. December 2023 Fed Funds implied rate has risen to 5.10% from 4.35%.
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