Top-Level Takeaways
- Interest rate volatility reached 2022 highs in June as an above-expectations May CPI report drove the first 75 basis-point (bp) Fed rate hike since 1994.
- Inflation worries morphed into recession worries and potential Fed policy error as the month progressed, leading to a partial retracement in Treasury yields.
- Volatility will likely remain a prevalent theme until signs of inflation subsiding emerge.
Interest rate volatility has been a dominant theme for fixed income markets in 2022, and June brought the highest levels of volatility yet. Inflation worries at the beginning of the month morphed into recession fears later in the month, fueling another wild ride for Treasury yields. The fireworks began on June 10 with two separate economic releases. First, May’s Consumer Price Index (CPI) report was alarming for market participants and central bankers alike, revealing higher-than-expected readings for headline and core inflation.
Later that morning, the University of Michigan consumer sentiment survey set a record low, which is remarkable given that the survey was initiated in January 1978. In other words, even with unemployment still near record lows, consumer sentiment was lower in June than it was during the Great Recession, 9/11, the dot com crisis, and the 1987 stock market crash. It shows the power of inflation as it relates to consumer psyche, and the report also showed long-term consumer inflation expectations surging 30 basis points to 3.3%. The final version of the survey revised inflation expectations down to 3.1%, somewhat easing those initial market worries.
The combination of these reports sparked a violent sell-off in the bond market, with the 2-year Treasury yield rising 54 bps in just two days as the market repriced for 75 bps rate hikes at both the June and July FOMC meetings. The Fed took the market’s cue and raised the fed funds rate’s target range by 75 bps on June 15, and the updated summary of economic projections (SEP) revealed a much more hawkish perspective from FOMC participants relative to the previous update in March. The median forecast now shows a 3.4% funds rate by year-end and peaking at 3.8% in 2023, more closely aligning with what the bond market had already priced.
The sharp repricing for an even more aggressive rate hike regiment, however, added fuel to growing worries that the major central banks will tip the global economy into recession in combating multi-decade highs in inflation. These concerns, regardless of validity, were enough to whipsaw the 2-year Treasury yield from its 2022 high of 3.45% on June 14 to as low as 2.74% on July 1. We’ve now come to a point where the market is more convinced that the Fed is willing to react aggressively to inflation risks following the 75 bps June hike, and as such, signs of still-elevated inflation have sparked an opposite reaction in Treasuries (i.e. bond yields falling on growing recession fears).
Read more about the latest economic data and overall market trends here.