The Zhitong Finance App notes that bond traders and Federal Reserve Chairman Kevin Walsh have reached a consensus on a key issue: the Fed's fight against inflation appears to be far from over.
According to the US Department of Labor report, US consumer prices fell month-on-month for the first time since 2020 in June, and the financial market breathed a sigh of relief — last week investors quickly settled their bets that “the Federal Reserve may start raising interest rates later this month.”
But it's likely just a temporary resurgence. After the US-Iran cease-fire agreement broke down, oil prices rose again. Despite concerns about the bubble impacting some tech stocks, huge spending on artificial intelligence continues to inject stimulus into the economy. And Walsh, who took over as chairman of the Federal Reserve two months ago, has made it clear that the central bank's priority is to keep inflation down — inflation has remained above the 2% annual target for the past five years.
As a result, traders still expect the Federal Reserve to almost certainly start raising interest rates before the end of the year, probably as early as September.
Ed Al Husseini, portfolio manager at Columbia Threadneedle, said, “If you don't do anything, are you confident that inflation will return to 2% or 2.5%? The answer is no. “He is betting that long-term bonds will outperform short-term notes, and this position will benefit from a more hawkish central bank position.” The Federal Reserve should be more comfortable raising interest rates without worrying about downside risks as before.”
Bond traders expect the Federal Reserve to raise interest rates soon
The Federal Reserve has maintained monetary policy stability since the last time it cut interest rates in December last year — the job market rebounded from the February slump, and Trump's war against Iran brought a new round of inflationary shocks to the global economy. These two major changes have broken expectations that the Federal Reserve will resume cutting interest rates even if Trump appoints Walsh to replace Powell — the president has attacked Powell several times for failing to reduce borrowing costs more quickly.
Since then, Walsh has signalled that he is eager to maintain the Federal Reserve's political independence and will not compromise with Trump's pressure.
At his first post-meeting press conference as chairman last month, Walsh repeatedly emphasized the need to keep inflation down. Last week on Capitol Hill, he reinforced this message, saying that the June consumer price index data does not mean that the Federal Reserve's mission has been completed. Three other regional federal bank presidents — Jeff Schmid, Lori Logan, and Beth Hammark — expressed a similar tone.
Although traders currently believe that the July rate hike is unlikely, they are still betting that the probability of a 25 basis point rate hike in September or October is high, and they regard the rate hike before December as almost a certainty.
Even so, the impact on financial markets is likely to be relatively mild, as US bond yields have risen ahead of schedule due to expectations. Since the end of February, 2-year US Treasury yields have jumped about three-quarters of a percentage point to nearly 4.2%, far higher than the 3.5%-3.75% range where the Federal Reserve interest rate is located.
The widespread rise in US bond yields has in turn boosted the cost of mortgages and other types of loans, and has done some of the work for the Federal Reserve by putting the brakes on the economy.
Chi Chen, co-manager of BlackRock's $18 billion total return fund, said, “If we are right about lower inflation and slower growth in the second half of the year, then the market is pricing a more hawkish path for the Federal Reserve than we expected.” “The Fed may continue to stay in the hawkish range and wait for the data to finally ease.”
As a result, her company is optimistic about medium term and short term bonds — the yield on such bonds increased during the sale after the Iran war.” The valuation is definitely more attractive than before.”
Two-year Treasury yields rose above the Federal Reserve's policy interest rate
Walsh has yet to say when the Federal Reserve will act, and is inclined to weaken the central bank's forward-looking guidance on interest rate trends, on the grounds that such guidance may make policymakers passive and unwilling to change direction. Federal Reserve officials won't release much new data or comments this week, as they are entering the usual period of silence before the two-day meeting that begins on July 28.
Strategist Edward Harrison said that if the Federal Reserve is unable to beat inflation, its “measures” to fight inflation will not bring dividends to investors. As the yield curve continues to steep and long-term real yields have not declined, the rise in treasury bonds on Tuesday still looked ominously like a “rebound.”
Bank of America economists expect the Federal Reserve to raise interest rates continuously at the September, October, and December meetings. After the June CPI data was released, they said in a report to clients that since inflation is still far above the Fed's target, “we need to see this data a few more times before we reconsider our current judgment.”
Colombian Threadneedle fund manager Al Husseini said that in an uncertain situation, we should take a cautious stance and not place heavy bets on positions that are greatly affected by the actions of the Federal Reserve. “Now is not the time to stretch your neck,” he said.