By David Barbuscia
NEW YORK (Reuters) – Expectations about how aggressively the Federal Reserve will raise interest rates in its fight against inflation reached a new high this week, exacerbating pressures on stocks and bonds.
Refinitiv data showed that while investors await another massive rate hike from the US central bank at its September 20-21 meeting, higher-than-expected inflation numbers raised bets on the so-called final interest rate, which now stands at 4.45% . .
This is more than 200 basis points higher than the current benchmark overnight rate and compares with the expected peak of about 3.7% just a month ago.
Higher interest rates in the US are likely to be unwelcome for stocks, which rallied over the summer, while bond yields, which move inversely with prices, have slipped from their highs on hopes the Fed will ease the pace of rate hikes.
Those hopes were dashed this week when the US Consumer Price Index for August showed inflation rose 8.3% year-on-year, more than economists’ expectations of 8.1%.
“I think the Fed is going to put another 150 basis points against 200 basis points to raise interest rates in the market, but the speed at which they do that is debatable at this point,” Jeffrey Sherman, deputy chief investment officer at Double Line said.
The Fed’s more hawkish forecasts also boosted real yields, which show how much an investor can earn on an annual basis holding US government bonds and reduce the attractiveness of riskier assets when they rise.
The 10-year Treasury Inflation Protected (TIPS) yield — known as real yields because it excludes expected inflation — rose to 1.03% on Friday, the highest level since January 2019. Since the beginning of August, real yields have risen nearly 100 basis points.
Meanwhile, benchmark 10-year Treasury yields rose about 8 basis points this week to 3.443%, courting a new 11-year high if they topped the 3.495% level hit in June. Goldman Sachs (NYSE:) said in a note on Friday that these returns could end the year at 3.75%.
The picture is not more rosy for corporate debt.
“Investors don’t seem to have much confidence in the Fed’s ability to engineer a so-called soft (or not very hard) landing,” said Danielle Polley, co-portfolio manager for Oaktree Diversified Income Fund.
The yield spread for the ICE (NYSE: BofA US High Yield Index), a commonly used benchmark for the junk bond market, rose to nearly 480 basis points this week, from 450 basis points before the CPI report.
“A rapid rise (in real rates) is generally bad in spreads when growth is below trend,” Barclays (LON 🙂 said the strategists in a note on Friday. “We don’t think this time will be different,” they said.