Top-Level Takeaways
- Rate volatility reached fresh 2022 highs in September as inflation persisted and central banks passed through significant monetary policy tightening.
- The FOMC announced a third consecutive 75-basis-point rate hike at the September meeting, marking 300 basis points of rate hikes in just six months
- Financial market conditions could become a greater focus for some Fed leaders moving forward, although most have suggested current inflation pressures reduce their response options at this point.
Interest rate volatility has been a major theme for fixed income markets in 2022. As we’ve noted several times this year, volatility will likely remain elevated until there is more clarity with regard to the path of inflation and the consequential Fed response.
The past two months provided no relief on either front. An overheated labor market and ongoing upside surprises for multiple inflation metrics fueled new highs for U.S. rates and rate volatility in September, and the Fed is showing no signs of relenting. The Citigroup Economic Surprise Index, which measures data surprises relative to market expectations, has moved steadily higher after reaching a 25-month low in June, thanks in large part to upside surprises for jobs and inflation data.
As a result, the Fed announced a third consecutive 75-basis-point rate hike at the Sept. 21 Federal Open Market Committee (FOMC) meeting, capping 300 basis points of rate hikes in a six-month period. Moreover, the updated Summary of Economic Projections revealed a median FOMC participant forecast of 125 more basis points by year-end, or 425 basis points in just nine months.
The ultra-hawkishness of the Fed has wreaked havoc in currency markets as well. The U.S. Dollar Index (DXY), which tracks the dollar relative to other major world currencies, ended September up more than 17% on the year, and the U.K.’s pound sterling reached an all-time low versus the dollar. Global central banks are forced to keep pace with the Fed or risk further currency depreciation while also battling emerging economic growth risks.
The volatility in U.K. government bonds (Gilts) last week was extreme and followed a curiously timed tax cut announcement by the country’s new government. The 10-year Gilt yield surged 130 basis points in just four days before the Bank of England (BoE) announced an emergency intervention to buy government bonds as needed to bring stability to the market, sparking an incredible 60-basis-point yield rally intraday last Wednesday.
The volatility expectedly spilled into other markets, including U.S. Treasuries. On Sept. 28, the 5-year Treasury yield experienced the biggest daily move since the Great Financial Crisis, and the 10-year yield traded in a 35-basis-point range last week, breaching 4% for the first time since 2008 just before the BoE announcement.
This market commentary is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Visit trustcu.com to read about the latest economic data and overall market trends.