US Rates Panic Again, As Fed Hawks Bleed Bonds

Traders bled the hawkish Fed narrative for everything it was worth on Thursday, as Jerome Powell mused about the merits of an accelerated tightening cycle.

“There’s something in the idea of front-end loading,” Powell reckoned, during an IMF panel discussion in Washington. It’s “absolutely essential,” he said, to “restore price stability,” without which economies “don’t work.”

He also confirmed what scarcely needed confirmation: A 50bps hike is on the table for next month’s FOMC meeting. Both New Zealand and Canada resorted to upsized moves to contain inflation earlier this month, and Jim Bullard went so far as to float a 75bps hike during a virtual presentation for the Council on Foreign Relations Monday.

The figure (below) is admittedly gratuitous, but it gives you some context.

Powell alluded to demand destruction, albeit cautiously. “Our goal is to use our tools to get demand and supply back in synch, so that inflation moves down and does so without a slowdown that amounts to a recession,” he said.

Of course, the Fed’s toolbox doesn’t include any implements capable of directly impacting supply chains. Their only levers are on the demand side. Powell conceded that the “soft-ish landing” he’s spent months suggesting is eminently feasible will in fact be a challenge. “I don’t think you’ll hear anyone at the Fed say that’s going to be straightforward or easy,” he remarked, of balancing demand and supply without inadvertently pushing the economy over the ledge.

Two-year yields jumped 15bps to a new cycle high Thursday (figure below).

Both 5s and 7s achieved a 3-handle. Markets priced in 50bps hikes in May, June and July, a succession that seems extraordinarily unlikely, especially considering waning growth momentum and forthcoming fiscal drag. Treasurys were also responding to a brutal selloff in the European front-end (amid ECB hike bets) and a matching rout in short-dated gilts.

Notably, pricing through the June meeting reflected more than 100bps of tightening, which in effect marked the first signs of adventurous traders betting on “a Bullard,” if you will. As it happened, Jim was on the record again Thursday. 75bps hikes have been done, he reminded markets. And the “world doesn’t come to an end.”

Earlier in the session, Eurodollars responded to remarks from Mary Daly, who called 50bps moves (plural) “likely.” Large block sales were seen in two-year notes and September 2022 eurodollar futures. The session also featured a barnburner five-year TIPS sale that boasted 89.5% indirect takedown (the average is 72%).

I’d be remiss not to suggest that Thursday’s overshoot felt quite a bit like the panic that rippled across rates in February, when Bullard’s urgent-sounding pleas prompted traders to ponder the odds of an inter-meeting move.

“It’s going to be very challenging,” Powell went on to say, commenting further on the prospects for a soft landing. “We’re going to do our best.”