US | Treasury yields fall amid strong optimism about inflation. Is it an overreaction?

Earlier this month, the Fed delivered the fourth consecutive 75bp hike, taking the fed funds rate to 3.25-4.00%. Last week’s positive surprise on inflation tilted the balance significantly towards an upcoming slower rate-hike pace, but 100bp worth of additional hikes still seem likely.

Key points

• Key points:
• Treasury yields reversed their upward course amid speculation that the Fed will pivot earlier than previously signaled to a less aggressive stance in its fight against inflation.
• The 10y-3m Treasury yield spread turned negative since late October, adding to the already widespread expectation that the US economy is heading towards a recession.
• The futures market is pricing in a 75% chance that the Fed will deliver a 50bp hike next month. Expectations that rates will remain restrictive throughout 2023 did not change dramatically.
• Optimism will likely lead to a slight easing of financial conditions, but it is important to consider that the Fed has been vocal about the risks of precipitously claiming victory.

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