Federal Reserve: Rate hiking path and global yields – BNY

BNY’s John Velis expects the Federal Reserve to raise rates by 25bp at this week’s FOMC meeting and sees another hike as likely later this year. While markets are pricing nearly 100bp of tightening through the end of 2027, Velis believes the US economy may struggle to sustain such restrictive rates for long. He also sees increasingly hawkish global policy expectations and pressure on longer-dated bonds, while warning that shorter-maturity yields may ultimately have moved too far.

Fed path, real yields and risks

"We expect the FOMC to enact a 25bp rate hike this Wednesday, in line with implied market probabilities, which currently price over a 90% likelihood of such action. The Fed’s expected move is also likely to feature one or more dissents in favor of a hold from less hawkish members of the Committee. At the July meeting when rates were held steady, three regional Fed presidents dissented in favor of a rate hike."

"While we expect a hike this week, and probably one more this year, we think the path to even higher policy rates is strewn with potential impediments to significantly tighter policy."

"We acknowledge a murky outlook for 2027 and the possibility of one or more additional increases in the funds rate next year, although we differ from the market in our H2 2027 outlook. The market sees a total of nearly four rate hikes (approx. 100bp) through the end of next year. We think that by then the economy won’t be able to handle rates that high for very long, and the Fed will be contemplating dialing back its restrictiveness toward the second half of the year."

"We do think that the nearly 100bp of hikes (equivalent to four hikes of the standard 25bp increment) currently priced in will be realized. We’re not ready to see shorter-maturity yields fall any time soon but think they may ultimately prove to be ahead of themselves."

"Dynamic factor modeling of the global rates and yield complex tells us two things: 1) the global risk appetite for long-dated bonds is deteriorating as time goes on, and 2) monetary policy expectations are getting more hawkish globally. As discussed above, for the U.S. at least, there’s a good chance that these hawkish expectations will be confirmed over Q4 this year, but may be somewhat overcooked and may stay that way for a few months, as markets begin to see more rate hikes, including from the U.S. However, there’s room for rate expectations to top out and even come in somewhat before too long."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)