Every so often I hear on Bloomberg or other sources that the market has priced in the next 2 rate hikes for this year. Do you guys think so? I'm not so sure. For one, it seems to me that speculators that enter the market with large positions unwind these positions very often. Also, when the rate hikes actually do come, aren't a shitload of investors going to buy the new higher yield bonds (thus pushing the USD higher)?
What you hear BBG say etc is a reflection of the current mkt pricing. Like all other things in the mkt, it's subject to change. It's neither right nor wrong at any given time. As to the investors buying the higher yield bonds, why would they want to do that if, at least in theory, cash in their account will yield a better rate?
When you say cash in their account do you mean money in the bank? Currently 10year yield is at 2.38%, I don't think any bank offers anything close to that.
Why are we talking about 10y bonds at all? Firstly, rate hikes aren't likely to have a mechanical effect on 10y bonds. In fact, the relationship between the two rates is tenuous and complicated, at best. For instance, 10y USTs were trading at a higher yield in 2013 when rates were at 0. Secondly, speaking crudely and simplistically, Fed hikes affect the marginal price of o/n cash in the financial system. For a normal person, the place where this should be felt most directly is in the pricing of their deposits. You're confused and, as a result, are asking rather confusing questions. What exactly are you trying to understand?
My very good friend Marty is correct as he usually is on discussions about rates. The Fed's role in the economy is to control "short term" rates, not the 10 year or 30 year. In fact they target 30 day fed funds. Further out in the curve the market pricing is reflective on many different factors as Marty pointed out. The market for the most part has priced in 2 rate hikes because the market in general is a discounting mechanism. So absolute changes in prices are not nearly as important as deviations from forward expectations. Marty...feel free to edit my post as you see fit.
No need to edit, as it's all correct... A small technical detail is that the Fed target is the federal funds rate which is an unsecured overnight interbank rate, rather than anything related to 30 days.
I am confused indeed, and missing something as usual. I understand that Fed funds rate has little to do with long term yields, but it closely connected to short term yields from my understanding. So one could make the assumption that short term bonds up to 2 years maybe will be more attractive when the rate hike does kick in. That might attract a flow of capital to these bonds and thus support the dollar at least short term. You mentioned that in theory cash in account should have a better yield than higher yield bonds. Can you elaborate?
Well, think about it from first principles, so to speak... Fed raises rates, so the entire yield curve responds. Let's assume that the response is, in fact, a parallel rise in yields. As you say, if I like buying short term bonds, they have become cheaper and will provide more yield. However, this is also true of, say, a 3m t-bill, a 1m t-bill and an overnight deposit. So, assuming I was indifferent before the hike and all else being equal, why would I now prefer to buy a 2y bond over a 1m bond or over just leaving my money on deposit?
If my understanding of overnight deposits is correct, well it still seems to be very low (in the 0.05% range from a few banks I looked at). Assuming a parallel rise in yields, a 3 month t-bill should return 0.9%, more than most deposits to my knowledge.