Bond Investors Prefer Short Maturities, Despite Hints of Decreased Rate Hikes

As the Federal Reserve hints it may slow its tightening pace in December, bond investors are still playing it safe on the short end of the yield curve, according to Reuters.

The Fed funds futures market has factored in a 68% probability of a 50-bps increase in December.

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"Our view is that the Fed will continue to tighten policy into 2023. We view price pressures as being well above their mandate and persisting into 2023," Tom Hainlin, National Investment Strategist at U.S. Bank Wealth Management in Minneapolis, told Reuters. "If our view is that inflation is a little more persistent and the Fed needs to be aggressive, then we still prefer to be on the shorter end of the curve."

To reduce losses, bond investors typically shorten the duration of their portfolios in an environment with rising rates.

Several Fed Presidents said it may be time to slow interest rate hikes. In October, St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari said raising rates should stop in early 2023. San Francisco Fed President Mary Daly agreed. "The time is now to start talking about stepping down," she told Reuters.

The impact of the rate hikes can feed into the economy when rate hikes are slowed down, according to analysts. But the market views this step-down as a precursor of rate-cutting, which many believe is not what will occur.

The challenge for the Fed is conveying that the slowdown will happen while price pressures continue to be elevated and reinforcing the message that the U.S. central bank’s goal is to bring down inflation, Tiffany Wilding, North American Economist at PIMCO, wrote in a research note.

"And . . . it isn't going to quickly pivot to dropping rates in the face of what is likely to be increasingly weak economic activity," she said.