Investors are skeptical that the Federal Reserve can tame the worst inflation in four decades without driving the economy into a recession.
That’s bad news for Americans, who face the prospect of a downturn as their bills for food, rent and fuel swell. But to bond investors hit by deep losses this year, it may mean any further pain will be short-lived, as a recession will spark the US central bank to cut rates next year. That’s according to the results of the latest MLIV Pulse survey.
Over 60% of 1,343 respondents in the survey said there’s a low or zero probability that the US central bank can rein in consumer-price pressures without causing an economic contraction. The survey was conducted July 18-22 and included retail and professional investors.
“Whether the Fed can successfully tackle inflation is uncertain because it’s a very challenging task,” said Tracy Chen, a portfolio manager at Brandywine Global Investment Management. “I don’t think the Fed will ignore the rising recession risk, but at the same time they are focused on inflation. So I’m still bearish on Treasuries -- but we are probably in the eighth inning on the upper limit for yields.”
Around two-thirds of MLIV Pulse respondents expect the 10-year Treasury yield to peak over the next nine months at below 3.7%. A move to the top of that zone of course would be rough for bond bulls, as the yield traded around 2.81% as of 7:48 a.m. on Monday in New York. Yet that expected peak yield isn’t too far from the 3.5% high seen in June, so overall losses wouldn’t be much worse than what was felt last month.
The rapid repricing in financial markets this year as the Fed pulled back its pandemic-era stimulus caused the 10-year yield to roughly double from March through mid-June. That pushed a broad gauge of Treasuries to a loss of nearly 12% by June 14, more than triple the record decline in 2009, according to Bloomberg data going back to 1973.
But the bond market has since rebounded, with yields dropping sharply on Friday after data showing a contraction in US business activity for the first time since 2020. Overall, yields have pulled back in recent week on speculation that tightening financial conditions are slowing growth. That would ultimately cause the Fed to halt its tightening and go on to loosen monetary policy next year. Such views were reflected in the MLIV survey, which found that most think the Fed will begin cutting rates in 2023.
Before then, a majority of those surveyed doubt the Fed will step up the size of its rate increases, despite some speculation it would opt for a full-percentage-point bump as soon as at the July 27 meeting. Most expect the Fed to keep a maximum speed of 75-basis-points per meeting, in line with the June increase that pushed its benchmark target rate to a range of 1.50-1.75%.
The funds rate will peak at 4% or less, in line with the range in Fed officials’ quarterly forecasts, a majority of the survey’s respondents said. Some 26% of investors went for more than 4%. And at the low end of the range, about 8% said it would be 3%.
Yet, inflation is expected to remain elevated: More than 50% of the survey respondents see the Fed’s rate below inflation when it peaks. That shows anticipation that the Fed would tolerate higher-than-usual inflation rather than continuing to raise rates during a recession.