Bond markets and rate hikes
The bond markets are the most impacted asset class by any changes to the Federal interest rates. The bond (BND) prices and interest rates are inversely related with inflation being another important factor in this relationship. For our discussion, assuming inflation remains constant, when interest rates rise, the required rate of return, also known as yield, increases, and bond prices fall.
How will bond markets react to a hawkish Fed
If the US Fed in its September meeting statement indicates the possibility of a December rate hike, bond yields along the yield curve are likely to rise. Inflation expectations have risen after the recent uptick in the August inflation and thus, the shift in yield curve is likely to be symmetric along the curve. Short-term bond yields (SHY) are likely to show minimal impact, while the ten-year (IEI) and longer-term (TLT) yields are likely to rise higher. Bond (AGG) yields fell to November 2016 lows in the previous month as rate hike expectations were completely written off.
Is the Fed going to surprise bond markets?
The US Fed, after its experience of the taper tantrum of 2013, has been careful with its announcements. The Fed has been taking care in preparing the markets for any changes to policy, and this time isn’t likely to be any different. The statement after this meeting could only give subtle hints about rate hike possibilities, and in the November statement, a strong signal could be sent out about a rate hike in December.