Under the bond market's relatively subdued response to the Wednesday's revised interest rate outlook is an expectation by traders that the central bank will not go as far as it thinks it can in raising interest rates.
While stocks were broadly higher and government bond yields were mixed, which some investors felt reluctant to believe about the Fed, the widely observed 2- to 10-year rate spread flattened – as did the 5-10 year spread. and 30 year returns. The flattening came despite policymakers anticipating an earlier than expected rate hike in 2022, saying a cut in monthly bond purchases "may soon be justified".
Ordinarily, government bond spreads would widen in anticipation of higher Fed rates, not shrink when the better US economic outlook is factored in. Instead, some strategists called the Fed's message cautious on Wednesday as it took less than expected policy makers into account, calling for an initial rate hike next year from the current range of 0% to 0.25%, and there was no formal announcement of a cut.
The flattening of the curve was accompanied by a shrinking spread between 2024 and 2026 Eurodollar contracts, the preferred tool for traders to express their views on future interest rate movements. The moves have been unusual as traders have started pricing in higher probabilities of a second hike in 2022, bringing the total number of potential hikes to eight over the next few years and the Fed funds' rate target of between 2% and 2.25% would increase.
Fed officials never managed to hit the Fed funds' interest rate target above 3%, even during the longest US economic expansion since records began, cut short by the pandemic last year.
"The treasury curve will flatten if the Fed has to reverse course and cut rates after 2024," said Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York. "It's an interesting dynamic, also reflected in Eurodollars, which suggests that after a series of rate hikes by Fed officials, the market thinks the Fed may need to loosen up again."
Stocks ended significantly higher on Wednesday, on the Dow Jones Industrial Average
increased by more than 300 points, or 1%, during the S&P 500
also advanced 1% to book their best days in about two months.