Fixed Income Viewpoints: Sparring with the Fed
The Viewpoints series gives investors Lazard’s perspectives on the latest macroeconomic and fixed income news and trends. In this edition, Lazard Asset Management's fixed income team share their assessment on the divergence between likely Fed interest rate policy and bond market expectations.
The Federal Reserve and the bond markets have not been seeing eye to eye lately.
The divergence between what the Fed plans to do with interest rates this year and what the bond markets think it will do seems to have reached a new high.
After its latest meeting on 4 May, when the Fed raised interest rates by 25 basis points (bps) to 5%–5.25%, Chair Jerome Powell said that the Fed was closer to pausing its rate-hike cycle and likely to keep interest rates steady after that. In the week that followed, however, pricing in the bond markets showed that investors expected the Fed to cut interest rates three times before the end of 2023 — potentially starting as soon as July.
Why the disconnect? The divergence reflects two different views of the U.S. economy. The Fed appears to see a resilient economy with inflation well above its 2% target and a very tight labor market spurring wage increases. But the bond market is focused on recent signs of slowing growth and tightening credit conditions following Fed hikes of 500 bps over the past 14 months.
At their meeting in mid-May, Lazard’s fixed income professionals discussed the combination of high inflation and slowing growth that has been challenging not just the United States but many countries around the world in different ways, with the very notable exception of China.
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