(Bloomberg) — A quiet market reaction to the Federal Reserve’s gradual announcement could be the eye of a storm as traders refuse to back down on bets that central bankers are too complacent about the risk of out-of-control inflation.
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Money markets are betting that the Fed will raise interest rates by about 17 basis points by June, odds that haven’t changed much at this week’s meeting and beyond. Eurodollar hedges are boosting demand – a sign that investors are keen to hedge against more aggressive bets on an interest rate hike.
Powell announced the start of reducing bond purchases on Wednesday, but said officials can be patient about raising interest rates. Higher interest rates suggest that traders are refusing to give Powell the benefit of the doubt, raising the risk that upcoming economic data will spark renewed volatility in the bond market.
“The FOMC’s insistence that this is still just a temporary shock” related to the pandemic and reopening of the economy “seems to be seriously behind the curve,” Paul Ashworth of Capital Economics said of the inflationary surge. But it may be some time before the Fed is willing to acknowledge that high inflation is likely to be more persistent.
While 10-year Treasury yields slipped on Thursday, trading three basis points lower at 1.57%, they are on track for a two basis point rise this week.
The next clash between impatient traders and calm policy makers comes early Friday, when US employment data is released. Next week, there will be a lot of inflation data for investors to consider, and there is also the unimportant matter of an imminent decision on Powell’s future as Fed Chair.
The Fed’s gradual announcement came after a week of violent volatility in global bond markets that exacerbated the sell-off this year – the worst since 2005. The collapse in Australian bonds after stronger-than-expected inflation shifted monetary policy encouraging traders to question the How far they can push the world’s central banks.
(Price updates throughout.)
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