The bond market may finally be getting the Federal Reserve’s message.
Traders are already mostly on board with the central bank raising rates at its June meeting, pricing in odds of a hike at almost 80 percent, judging by the current effective fed funds rate and the forward overnight index swap rate. But they’re also growing more confident that the Fed will go again in September, with the probability of such a move approaching 40 percent on Tuesday, about double what it was a week ago.
Financial markets aren’t waiting to find out if this is the year Fed policy makers stick to their forecast, which is for two more hikes in 2017. Two-year yields touched 1.35 percent Tuesday, the highest since March, while the Bloomberg Dollar Spot Index reached the strongest in almost a month. Both were little changed Wednesday.
“The Fed is very consistent this year: They’re saying, from their standpoint, the unemployment rate and the path it’s going is below where they think is full employment,” said John Herrmann, director of rates strategy at MUFG Securities Americas Inc. “It’s consistent with removing accommodation further at the June meeting, and perhaps at the September meeting like we expect.”
Fed officials said last week that they view a recent deceleration in economic growth as likely to be transitory, meaning they could continue raising rates as soon as next month. That stance gained credibility two days later when the jobless rate unexpectedly dropped to 4.4 percent, the lowest since May 2007.
Market-based measures of inflation expectations, meanwhile, remain close to the Fed’s 2 percent target. While down from January’s highs, the U.S. 10-year breakeven rate is 1.86 percentage points, compared with about 1.6 percentage points a year ago.