Bond Investors Have A Unique Take On Where Interest Rates Are Headed

Bond Investors Have A Unique Take On Where Interest Rates Are Headed
Stéphane Renevier, CFA

almost 2 years ago1 min

If you’re not familiar with eurodollars, they’re short-term dollar-denominated bonds held in banks outside the US. That means they’re free from regulation by the country’s central bank and less manipulated than markets inside the States, but that they’re still highly liquid. That combination makes them an ideal way of working out (with some very complicated math) how much of a percentage rate hike bond investors are expecting, in what’s known as the “eurodollar gauge of implied rate hikes”.

That gauge is depicted in the chart above, where you can see what investors have been expecting since last October with regards to two different periods of interest rate hikes: from the present day till June 2023 (black line), and from June 2023 till December 2024 (orange line).

The recent divergence between the two is interesting. Investors are now expecting more aggressive hikes until June 2023: a full 2% hike versus 1.25% at the beginning of the month. Meanwhile, they’re expecting cuts between June 2023 and December 2024. That’s probably because they think hikes will significantly drag on economic growth, which would probably force the Federal Reserve to change tack and lower rates again. That suggests bond investors think a “soft-landing” scenario – where the Fed manages to hike rates without troubling the economy too much – is pretty unlikely.

That’s quite different from the Fed’s point of view: it’s said it thinks it’ll be able to keep rates steady from the second half of 2023. More importantly, it’s at odds with the recent rally in stocks, which suggests stock market investors aren’t too worried about the negative impact of higher rates. But if bond investors are right, maybe they should be…

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