Market Still Leaning The Wrong Way On The Fed

As we’ve discussed over the past few months, markets can be wrong—sometimes very wrong.

On that note, consider that the yield on the U.S. ten–year Treasury was trading closer to 2.30% after the Fed’s first rate hike last December—the first hike in nearly ten years and the symbolic move away from the emergency zero interest rate policy. The ten–year yield has, incredulously, traded as low as 1.53% since. One end of that spectrum is wrong, very wrong.

Remember, as we headed into the last Fed meeting, the ten–year yield was trading just shy of 2% (after a wild ride down from the December hike date). And the communication to that point from the Fed was to expect FOUR rate hikes in 2016.

Of course, in the face of another global economic crisis threat, which was driven by the oil price bust, the Fed did their part and backed off of that forecast—taking two of those hikes off of the table. Still, yields under 2% with even two hikes projected seemed mispriced.

So following a dramatic 85% bounce in oil prices and the threat of cheap oil now behind us (seemingly), as of yesterday afternoon yields still stood around just 1.79%. That’s more than a 1/2 percentage point lower than the levels immediately following the December hike. And that’s AFTER two voting Fed members just said on Tuesday that they should go two or threetimes this year. So with global risks abating, the Fed is beginning to walk back up expectations for Fed hikes.

Confirming that, as of yesterday afternoon, the minutes from the most recent Fed meeting have been disclosed, which now indicate that a June hike is likely assuming things continue along the current path (i.e. no global shock risks emerge).

Still, the yield on the ten–year Treasury is just 1.84%, 5 basis points higher than it was yesterday morning, prior to the Fed minutes.


The bet is that the Fed is making a mistake raising rates (at all). But at these levels for the ten–year yield, it’s a very asymmetric bet. The downside for yields here is very limited (short of a global apocalypse), the upside is very big. That makes betting on lower yields a very dangerous one, if not a dumb one. When people are positioned the wrong way in asymmetric trades, the adverse moves tend to be violent. I wouldn’t be surprised to see 2.50% on the U.S. ten–year Treasury by the year end.

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