Leading Economist Warns: Markets Are Misinterpreting Interest Rate Outlook
Julius Baer economists reviewed the Fed's decision to hold rates at 3.5%-3.75%. Despite market pricing, experts argue there is potential for further declines in US Treasury yields.
Economists at the wealth management bank Julius Baer conducted an economic review addressing the US interest rate decision, which remained unchanged, and the heavy pressure on Japanese corporate bonds.
David Kohl, Chief Economist, and Afonso Borges, Bond Research, Julius Baer:
"At its July meeting, the Federal Open Market Committee (FOMC) left the federal funds rate range unchanged at 3.5%-3.75%. Although the decision was in line with our assessment, the markets priced in a probability of about 30% for a rate hike."
As a result, US government bond yields at the short end of the curve fell by more than 10 basis points, and the yield curve recorded its sharpest steepening in almost a year. Notably, three committee members — Beth Hammack, Neel Kashkari, and Lorie Logan — voted in favor of a rate hike.
In the absence of clear guidance, markets are trying to infer the Fed's next step from these minority votes and continue to price in about two rate hikes over the coming year. We maintain our estimate that the Fed will leave the interest rate unchanged during this period, and therefore believe there is room for a further decline in US Treasury bond yields.
Fed Chair Kevin Warsh reiterated the promise to 'restore price stability' but refrained from providing specific hints regarding future policy. He stated that markets should 'play the ball, not the referee,' indicating the Fed's desire to be less committed to a pre-defined interest rate path.
Magdalena Tao, Asia Bond Analyst, Julius Baer:
"As long as a clear funding plan for the planned tax cuts is not presented, there is potential for a further increase in the fiscal risk premium of Japanese assets. This is expected to weigh on Japanese Government Bonds (JGBs) and the yen."
Prime Minister Sanae Takaichi's government plans to reduce the consumption tax on food and beverages from 8% to 1% for two years, starting next April. The cost of this measure is expected to exceed 4 trillion yen, yet no funding source has been presented. Investors fear that fiscal policy is becoming more expansive precisely as inflation concerns rise.
The Bank of Japan is expected to keep rates unchanged, with focus shifting to Governor Kazuo Ueda's remarks. If he does not signal a faster pace of rate hikes, the yen could weaken to 165 yen per dollar.
