Bond yields surge after Fed’s third consecutive 0.75% interest rate rise

The decision by the US Federal Reserve (The Fed) to hike interest rates by 0.75%, amid escalating fears of a recession, resulted in a Wall Street sell off, with the S&P 500 index down -0.8% to 3757 points while the Nasdaq index fell -1.3% to 11,066 and the Dow Jones Industrial Average index was- 0.3% lower to 30,076 points.

Meantime, the 10-year yield rose to 3.71%, its highest level since 2011.

The two-year rate also rose for an 11th straight session, which marked the longest up run up in over 30 years.

Heightened fear of recession

What caused the market to panic was The Fed’s most unambiguous signal yet that it’s prepared to endure a recession in return for regaining control of inflation.

There’s now talk of a further 1.25 percentage points of tightening before year-end.

According to new projections released on Wednesday, most Fed officials expect to raise rates to between 4% and 4.5% by the end of this year.

Fed officials also expect the unemployment rate to rise to 4.4% next year, from 3.7% in August and 3.5% in July.

No painless option

Investors should note that historically, an increase of that magnitude and in that space of time has coincided with a recession.

“We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t,” Fed Chairman Jerome Powell noted in a news conference after the rate decision.

The Fed was not alone in raising rates with the Bank of England announcing a second consecutive half-point rate increase, while the Swiss National Bank was the last European central bank to exit negative interest rates with a 0.75% rate hike.

10-year Aussie up

Heightened fear of recession also led to a heavy Australia's bond market sell off, with the Aussie 10-year yield surging 18.5 basis points to a three-month high of 3.84%.

The 3-year yield is also up 21.1bp to a three-month high of 3.527%.

With US markets expected to continue selling off, following heightened fears of recession, June highs at 3.69 and 4.255% respectively – last reached around a decade ago – are also likely to be tested.

A$ higher

The A$, which has fallen from a high of 75.78c against the US$ in April, also rose from lows near US65.74c to finish at around US66.40c at the US market close.

The A$ has already fallen -1.3% to a two-year low of US65.83c since the Fed initially lifted Fed funds rate 75 basis point, which was always going to be the precursor to sharper higher and more sustained US interest rate increases than initially expected.

Will the RBA become more hawkish?

Investors should note that A$ weakness is the means by which aggressive US interest rate hikes will be transferred to Australian interest rates, hence putting upward pressure on the price of imported goods.

With the market sensing that Reserve Bank (RBA) governor Philip Lowe’s hands are somewhat tied on what happens from here, the jury’s now out on whether the RBA will be spooked into lifting interest rates more than it wants to.