The Fed hiked by 50bps as expected, but the dot plot was what got the attention from markets. Higher rates, for longer, and Powell repeated in the press conference the need to get tough on inflation. US GDP is expected to be lower than September’s projections and US unemployment higher once we get through 2023. However, the bond market did not reflect the messaging from the Fed, so that was an interesting tell.

The dot plot

Take a look at the dot plot. The 2023 projections are now for a 5.1% median hike in 2023 and the first cut is not to come until 2024. Two Fed members see rates holding above 5% in 2024.

In the Press Conference Powell reaffirmed the Fed’s 2% inflation target. He was pleased that recent inflation data was showing signs of falling, but Powell said that by now he would have expected faster progress on inflation. So, Powell is not yet happy with the speed of progress and has communicated that to the market. However, the bond market was not listening.

The bond market reaction

Typically in this situation, you would have expected the bond market to sell off sharply and yields to rise. That didn’t happen. You can see US 10-year yields stayed pretty flat through the meeting. Why?

The bond market is not buying the messaging. They don’t see the Fed going much higher and are indicating that a peak of around 5% seems about right. Money markets see a peak of 4.90% and there was not much of a shift post the US rate statement. See the implied interest rate curve from Financial Source’s terminal below.

So, what does this mean? It means uncertainty. Who is right? Bond traders who see the job done and inflation coming down? Or is the Fed right that more progress should have been seen on inflation by now? One thing for sure is that the Fed is not going to take its foot off the gas until more obvious signs of inflation falling are seen. This makes for turbulent trading ahead, but bond traders tend to take the long view and there is a saying in markets that the ‘bonds are the truth’. Are they telling the truth this time that the first battle against inflation is won?