All of a sudden, the prospect of U.S. rates hitting 6% is becoming real enough for investors to rethink their strategies.
BlackRock Inc. and Schroders Plc are among those who are weighing in on the debate of what will happen if U.S. rates peak at 6%. As late as end-February, investors across bonds, stocks and currency markets were still calling for an end to higher rates with bets for a broad rally in the second half.
Instead, Federal Reserve Chair Jerome Powell's testimony on Tuesday is fueling expectations of a bigger hike this month, with traders pricing in peak rates of 5.6% from less than 5% at the end of last year.
Treasury traders are doubling down on recession expectations, the dollar has rebounded while equity markets from the S&P 500 Index to the MSCI Asia Pacific gauge are giving up gains.
Given the robust job market and sticky inflation, "we think there's a reasonable chance that the Fed will have to bring the Fed Funds rate to 6%, and then keep it there for an extended period to slow the economy and get inflation down to near 2%," Rick Rieder, chief investment officer for global fixed income at BlackRock, said in a Tuesday note.
The Federal Reserve's latest messaging sets the stage for the central bank to revert to a half-point hike, and stands in marked contrast to the softer stance adopted by peers in Australia and Canada. It's also fueling fears of a hard landing for the U.S. economy as the bond market telegraphs the growing odds of a recession.
Swaps traders are now pricing in a full percentage point of Fed hikes over the next four meetings.
"A 6% terminal rate is not out of the question now," said Kellie Wood, deputy head of fixed income at Schroders Plc in Australia. "Expect to see a broad-based selloff in Aussie and Asian markets today led by the short end but with U.S. rates underperforming."
In the U.S., the spread between 2- and 10-year yields are showing a discount larger than a percentage point for the first time since 1981, when then-Fed Chair Paul Volcker was pushing through hikes to tackle double-digit inflation. The yield inversion indicator has over the decades anticipated recessions in the wake of aggressive Fed tightening campaigns.
