Fed's Rate Hike Pause Fails To Dissuade Bond Traders From Betting On A Recession — Here's Why

Bond traders appeared to be increasing their bets on the probability the Federal Reserve will likely tip the U.S. economy into a recession as is apparent from the steepening of the yield curve inversion. Bloomberg had earlier reported the story.

Despite the central bank pausing its rate hike campaign for the first time since it began its aggressive monetary policy cycle, the Fed's indication that it could raise rates by another 50 basis points this year led to a sell-off in policy-sensitive short-dated securities, causing a rise in yields. At the same time, yields on long-dated bonds fell pushing the yield-curve inversion between two and 10-year yields to over 90 basis points, according to Bloomberg.

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Expert Take: George Goncalves, head of US macro strategy at MUFG told Bloomberg the Fed runs the risk of solving one policy error of being too easy for too long with another policy error as they ignore the growing credit contraction and persistent losses from higher rates. "The catch-22 is that for them to ease, something now has to break or the economy has to crack," he said.

The two-year yield touched as high as 4.8% before cooling down to 4.71% on Wednesday. At the same time, the 10-year yield touched a low of 3.77% from the high of 3.85% this week. A yield-curve inversion is considered a precursor to the possibility of a recession.

The iShares 1-3 Year Treasury Bond ETF SHY shed 0.06% on Wednesday while the Vanguard Short-Term Treasury Index Fund ETF VGSH lost 0.05%, according to Benzinga Pro.

Michael Cudzil, portfolio manager at Pacific Investment Management Co. told Bloomberg the Fed was clearly trying to send a hawkish message that they are not quite done yet and don't think they have made enough progress on inflation. "You see curve flattening and rates not pricing in the full extent of hikes, so the thinking is that these hikes may bite and the Fed is closer to the end," he said.

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