US | Markets price higher rates, not a less independent Fed

Summary

After moderating in April, expectations for Fed rate hikes, as implied by the 2-year Treasury yield, strengthened again in May, driven by uncertainty surrounding the prolonged conflict in the Middle East, resilient economic activity, and the Fed’s hawkish tone adopted in its latest policy decision.

Key points

• Key points:
• The shift in the curve was particularly eye-catching at the long end, where 30-year yields reached 5.2% in mid-May, a level not seen since the onset of the GFC in 2007.
• Broad measures of bond market volatility have remained mostly below their historical averages, pointing to continued orderly market functioning and limited signs of stress.
• The somewhat narrower 30y-10y yield spread suggests that investors do not (yet?) perceive a meaningful long-term threat to the US exorbitant privilege.
• The rise in Treasury yields toward their mid-May peak was initially driven by a higher term premium, followed recently by a growing contribution of policy rate expectations.
• Markets appear to be pricing a higher-for-longer fed funds rate while remaining broadly confident that inflation will remain under control.

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