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

Summary

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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