A barrage of comments from FOMC members last week has bumped up market expectations of Federal Reserve rate hikes. However, it’s not clear that market players are adjusting their rate expectations correctly; the U.S. Treasury curve has steepened (Figure 1).
Granted, some of the increase in steepness is likely also due to the ECB deciding against expanding its own QE program at its meeting last week, so UST curve steepening makes some sense. However, to the extent the shift is a reaction to the heightened expected path of fed fund rate hikes, market players are likely missing some of the macroeconomic consequences Fed tightening as they price the increased odds of a hike into long-term rates. Economic conditions are not materially different than in December, the time of the last Fed rate hike. When the Fed hiked in December, the ensuing market volatility encouraged a flight to safety and lowered the Fed’s projected speed of hiking rates, which ended up flattening the yield curve (see Figure 2).
The Treasury curve steepening going on today may be a good opportunity for a relative value trade. Whether the Fed hikes or not, long yields will likely fall.