Accelerated Tapering, Earlier Hike, Curve…Steepening?

Fed Chair Powell makes news

Fed Chair Powell made news today as he laid out the risk that the Fed will accelerate the pace of their bond purchase tapering. The Fed Chair and Treasury Secretary Yellen were testifying before the Senate Banking Committee and Powell used this as an opportunity to deliver a message to the market. This is not that usual, and the market reacted accordingly with estimates of the Fed doubling their planned $15 bn. per month of tapering apparently making the rounds of bond dealing desks. This could see the Fed being done and dusted with bond purchases by March 2022, which is moving rate hike expectations forward. This makes their 16 December meeting a very much ‘live event’ for investors.

Money market moves

Money market traders have been shifting their bets on the Fed’s first rate hike all year long (chart below). Keep in mind that the market started the year with initial rate hike expectations for this cycle drifting around late 2023 or H1 2024. This changed over the summer though and really started to shift over the last few months as rate hike expectations were brought forward. Fed Chair Powell seems to be throwing a fox into the chicken coop now and the current futures implied money market curve shows a much steeper curve for 2022 – earlier and persistent rate hikes.

Go early, but regret it?

The market is also seeing the 2-yr. Treasury note yield tick a touch higher today (chart below). The spread with the 10-yr. Treasury note yield (coupon curve, red line) is flattening though, which seems to reflect the view that while the Fed may hike sooner than expected (and push the 2-yr. note yield higher), there is no real ‘push higher’ on 10-yr. note yields to rise beyond the 1.75% area peak seen in March 2021.

This seems to suggest that a policy mistake may be in the offing – hiking too early and slowing growth or that inflation risks will indeed be transitory, so 10-yr. note yields (chart below) won’t see 2.0% broken after all. While this could be right, our view is still focused on the 10-yr. note yield pushing to 2.5% and then 3.0% in this cycle – with the coupon curve steepening towards 200 bp. Interesting times ahead!

Gerry Celaya

Chief Strategist