USD Rates: How much did Fed pricing shift?

Fed pricing did not shift much.
Eugene Leow09 Nov 2021
    Photo credit: Unsplash Photo

    Developed market rates had an about turn last week as market reassessed how central banks would react to elevated inflation. However, we prefer not to react too much to overly aggressive swings in either direction. AUD and GBP rates corrected significantly and for good reasons. The market was caught wrong footed twice for AUD rates, initially too dovish and after that too hawkish. For GBP rates, the market had largely anticipated a hike, which did not materialise. Unfortunately, this has a knock-on impact unto other DM rates, which might not be warranted. Did market pricing for the Fed shift? 

    The short answer is not much. There are multiple instruments to look at here, we focus just on Fed funds futures, to avoid having to disentangle the basis between short rates. If we look at end-2024, Fed pricing has pushed higher to 1.57%, after a brief dip late last week. This means that the market still sees the Fed hiking by 150bps to 1.75% over the next three years or so. The end-2022 contract stands at 0.53%, down from a recent peak of 0.61%. The market has simply pushed back Fed hike expectations a tad, but still see broadly the same amount of tightening over the coming three years.

    However, it must be noted that rally in US Treasuries was driven by the longer-tenors as the curve flattens. We are not convinced that 10Y and 30Y yields should hover below 1.5% and 2.0% respectively. While the Fed will be slower to react to inflationary pressures under the average inflation targeting (AIT) framework, it would not ignore inflation entirely. As such, an extended period (beyond supply chain disruptions) of very low real yields does seem unlikely and is more consistent with a more pessimistic stagflation-lite outlook.

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]


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