Bond sell-off eases as investors await next week’s FOMC meeting

Most major currencies have traded within relatively narrow ranges versus the dollar in the past couple of trading sessions, as the scorching move higher in US yields pauses for breath and investors patiently await next week’s FOMC meeting.

Activity in financial markets so far in 2022 has been largely characterized by the sell-off in bond markets globally. Easing concerns surrounding the economic impact of omicron, combined with heightened bets that most major central banks will raise interest rates at an aggressive pace this year, have largely been behind the move. The development has not just been a US phenomenon, even if financial news outlets would perhaps lead one to believe otherwise. In the UK, the 10-year Gilt is up around 25 basis points since the start of the year, while in Germany the 10-year yield rose above 0% this week for the first time since May 2019. The most noteworthy move has, however, been witnessed across the Atlantic. The US 10-year Treasury has jumped by over 30 basis points since the start of January as markets frantically price in a total of four interest rate hikes from the Federal Reserve in 2022.

Figure 1: US 10 Year Treasury Yield (1 year)

Source: Refinitiv Datastream Date: 21/01/2022

Bond investors will perhaps be keen to not get too carried away with themselves ahead of next week’s FOMC meeting, which may shed greater light on the bank’s plans for the coming year. The shift in the FOMC’s monetary policy stance since September has been rather remarkable. At its September meeting, the Fed indicated that it only expected to raise rates on one occasion in 2022. Since then, however, policymakers have become increasingly more hawkish as US inflation continues to march to multi-decade highs and price pressures show no signs of abating just yet. At its most recent meeting in December, the Fed formally acknowledged that the spike in prices was no longer seen as ‘transitory’.

The bank’s ‘dot plot’ was also revised up significantly from September, with the median dot suggesting that the Fed is now on course to raise rates on at least three occasions in 2022.

Since the December meeting, comments from FOMC members have remained hawkish, US inflation has broken to a fresh four-decade high and data on the omicron variant suggests little need for the return to the strict lockdowns that have been commonplace since the start of the pandemic. All signs suggest that an interest rate hike is coming sooner rather than later, and while next week’s meeting is too soon for such an announcement, we expect the bank’s rhetoric to pave the way for one when the FOMC convenes at its 15-16th March meeting. Whether this will be enough to trigger a move higher in the dollar next week remains to be seen, although with markets now fully pricing in a hike in March, we think that the Fed would have to do something special to trigger any meaningful gains in the greenback.