(Bloomberg) — Bond traders haven’t moved so swiftly to get ahead of the Federal Reserve in at least four decades, underscoring the dramatic tightening in financial conditions that has rippled across markets even before the central bank starts raising interest rates.
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Yields on two-year Treasuries, which are highly sensitive to changes in monetary policy, have surged from 0.28% since the end of September to about 1.87% as traders prepare for the cycle of hikes that’s expected to begin Wednesday.
That’s a steeper and faster jump than before any of the Fed’s liftoffs since at least the early 1980s, according to data compiled by Bloomberg. The two-year yield rose just 41 basis points during the six-month period before the Fed started raising borrowing costs in December 2015. It climbed 86 basis points in the same periods leading to the first hikes in June 2004 and 98 basis points in June 1999.
The scale of the bond market’s recent moves shows how fast the expectations of the Fed’s policy have changed since Chair Jerome Powell pivoted to combat the fastest inflation in four decades. The central bank is lifting off just a week after ending the final round of its massive asset purchases that had been injecting monetary stimulus into the economy since early in the pandemic. JPMorgan Chase & Co.’s strategists called it “the shortest interregnum between easing and tightening” in modern monetary history.
“The market has interpreted recent inflation developments to mean that the Fed will act more aggressively,” JPMorgan’s strategists led by Jay Barry wrote this week.
The move in two-year yields reflects speculation that the monetary tightening will be front-loaded, with policy makers expected to be mindful of not raising rates so far that the economy is pushed into a recession. Futures markets show traders anticipate the Fed will boost borrowing costs in each of the remaining six meetings this year after lifting it a quarter percentage point Wednesday, taking the benchmark rate to just below 2% by December.
The Russia-Ukraine war has pushed up government bond yields further as the rise in oil and commodity prices threatens to add to inflation pressures, helping widen the credit spreads and hammering some high-flying stocks. Treasuries have slid to a 4.7% loss this year, which is a bigger drop than the market has seen in any full year since at least 1974, according to Bloomberg’s index.
As short-term rates surged, the yield curve flattened, suggesting investors expect the monetary tightening may slow down the economy. The difference between two-year and 10-year yields has narrowed to around 30 basis points from 121 basis points at the end of September. The forward market has indicated that the curve may invert next year, a move that is widely perceived as a precursor to recession.
(Updates to add yield levels in second paragraph.)
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