Hawkish Fed with Growth Alarm affecting Bond Traders in Stock Market

After the Federal Reserve raised interest rates and signaled hikes at all six remaining meetings this year, a section of the Treasury curve — the gap between five- and 10-year yields — inverted for the first time since March 2020. Meanwhile the flattening trend between two- and 10-year yields continued.

On Wednesday, the Fed raised interest rates to a range of 0.25%-0.50% and indicated that it intends to quash inflation, which is running at 40-year highs, more quickly than it previously expected. It signaled at least six further rate rises this year, in line with market expectations, and several more in 2023.

The dollar index, which had gained 3 percent since the start of the Russia-Ukraine war on February 24 and 10 percent since May, fell as much as 0.6 percent on Wednesday as traders parsed Fed statements following a two-day meeting.

“Fed’s projections of another six hikes this year is hawkish and, therefore, the smart rally in markets with S&P 500 and Nasdaq posting 2.24% and 3.7% upmoves respectively was a bit unexpected. The explanation is that the market was oversold and the consequent short covering pushed indices higher. The market drew confidence from the Fed chief Powel’s statement that “the American economy is very strong,” said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

The aggressive rate hike outlook has come in response to the US witnessing a run-away inflation exacerbated by rising commodity prices led by geopolitical tensions and supply disruptions, and posed with downside risks to global growth.

The MSCI All-World index was up 0.8%, heading for a gain of 3% this week, aided by a strong rebound in Asian markets. Hong Kong’s Hang Senggained 7% as beaten-down tech giants like Alibaba and Tencent roared higher, and Tokyo’s Nikkei rallied over 6%.

Bond yields, which initially jumped to near three-year highs on Wednesday, eased back by Thursday, in line with a weaker dollar. The two-year Treasury yield, which is the most sensitive to interest-rate expectations, was last down 1 basis point at 1.932%.

The Bank of England meets later and is widely expected to deliver a third rate hike this year, as it, too, struggles to contain punishingly high inflation.