The Tell: Behind bond market’s muted response to Federal Reserve’s rate outlook may be a message for policy makers


Underneath the bond market’s relatively muted response to the Federal Reserve’s revised rate outlook on Wednesday is an expectation from traders that the central bank won’t get as far as it thinks it can on raising benchmark policy rates.

While stocks were broadly higher and Treasury yields were mixed on what some investors perceived to be a dovish message from the Fed, the widely watched spread between 2- and 10-year rates flattened — as did the gap between five- and 30-year yields. The flattening came even though policy makers had penciled in a sooner-than-expected rate hike for 2022, and said a tapering of monthly bond purchases “may soon be warranted.”

Ordinarily, Treasury spreads would be widening, not shrinking, in anticipation of higher policy rates from the Fed as brighter U.S. economic prospects get priced in. Instead, some strategists described the Fed’s message on Wednesday as dovish, considering fewer-than-expected policy makers called for a first rate hike next year from the current 0% to 0.25% range, and there was no formal tapering announcement.

The flattening curve was accompanied by a shrinking spread between 2024 and 2026 Eurodollar contracts, the preferred tool of traders for expressing views on future interest-rate moves. The moves were unusual since traders have begun pricing in higher probabilities of a second hike in 2022 that would bring the total of potential hikes in the next few years to eight, boosting the fed-funds rate target to between 2% and 2.25%.

Fed officials never managed to get the benchmark fed-funds rate target above 3%, even during the longest U.S. economic expansion on record, which was cut short last year by the pandemic.

“The Treasury curve is flattening on the chance that 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 that’s also being reflected in Eurodollars indicating that, once there’s a series of rate hikes by Fed officials, the market thinks the Fed may have to go easing again.”

Stocks ended sharply higher Wednesday, with the Dow Jones Industrial Average 

 up more than 300 points, or 1%, while the S&P 500

 also advanced 1% to book their best days in about two months.

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