Bond Market to Fed: Rate Outlook Is Too High

Traders expect Fed overnight rate to max out at about 3.3 percent during this expansion, lower than Fed's own estimate of 4 percent.

The bond market, unparalleled in predicting shifts in the U.S. economy over the decades, has a message: Interest rates aren’t going to rise as high as even the Federal Reserve’s own forecast.

From bond yields to futures and swaps, traders see little chance the economy will strengthen enough over the course of its expansion to compel the Fed to lift its overnight rate beyond about 3.3 percent. That’s less than the historical average of 4.25 percent that New York Fed President William Dudley said would be consistent with the central bank’s current target for inflation and compares with its long-term estimate of 4 percent.

Evidence that a weaker labor market will constrain demand and inflation, which has fallen short of the Fed’s 2 percent goal for 23 months, has caused investors to pour into government bonds. That upended economists’ predictions for a second year of losses as a strengthening economy prompted the Fed to reduce its $85 billion-a-month bond buying program.

Treasuries due in 10 years or more have returned 10.6 percent this year, the most on a year-to-date basis since 1995, data compiled by Bank of America Merrill Lynch show. Yields on 10-year notes, which fell more than a half-percentage point to 2.47 percent on May 15, ended at 2.53 percent last week. The yield was 2.54 percent as of 8:55 a.m. in New York.

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