Despite the hawkish commentary from the US Fed on June 12, there is reason to believe a swift shift in the Fed's stance may be around the corner, says Ritesh Jain, an expert on global macros and bond markets. Drawing attention to the 2-year bond rates, Jain noted that the Fed funds rate follows US 2-year bond yields with a lag. "A gap has opened up between the 2-year bond yield and the Fed funds rate, and this is just too tight," he said.
The US 2-year bond yield ended June 12 at 4.74 percent, falling sharply after the inflation data release. This creates a gap of 50 basis points. "This gap highlights the discrepancy between market expectations and the Fed's current stance. The Fed may need to adjust its policy stance sooner rather than later to align with market signals," says Jain.
Also read: US Fed's new ‘Dot Plot' forecast signals only one rate cut by end of 2024
The question is, could the markets be wrong? Could they be running ahead with expectations? Jain says that historically, since 1989, data shows the Fed follows the 2-year bond yields. Besides, the market closed with gains on all counts—both on equities and bonds—even as the dollar declined.
Read more: Party time on Wall Street even as US Fed takes hawkish stance; S&P 500, Nasdaq hit record highs
Both US bond yields and equity markets saw a sharp rally after the inflation print, before giving up part of the gains after the policy announcement as the Fed Dot Plot showed only one cut rather than three. The US 2-year yield touched 4.67 percent reacting to the surprise inflation data but closed at 4.74 percent. It still ended with gains of nine basis points, primarily because the market believes the Fed Dot Plot does not reflect the reality of the latest inflation figures. "The market actually rallied a lot more with a steep drop in yields after the inflation data came out but did not give up all the gains despite the super hawkish commentary. This is very positive," Jain said.
However, all this assumes that the latest inflation numbers continue to remain soft and head lower. Any sharp surprises could change the stance again, he added
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