Though some investors are sceptical that the US Federal Reserve will stick to its guns, the central bank’s intentions for a protracted period of high interest rates might continue to pressure equities and bonds in the months to come.

In accordance with market forecasts, the U.S. central bank kept interest rates unchanged on Wednesday. However, with another rate increase anticipated by year’s end and monetary policy predictions being substantially tighter through 2024 than anticipated, authorities strengthened their hawkish stance.

In general, prolonged periods of higher rates could be unfavourable for equities and bonds. After soaring in recent months, the benchmark U.S. Treasury yield, which moves counter to bond prices, now stands at its highest level since 2007, and might go more if rates continued to stay at a high level.

Stock prices are further hampered by elevated yields on Treasuries, which are viewed as a risk-free alternative to equities since they are supported by the U.S. government. The S&P 500, which has gained 15% year to date, has had difficulty moving past its peak from late July as the yields increase has escalated.

On Wednesday, the S&P 500 fell 0.94% while the yield on two-year Treasuries, which measures future interest rates, reached a 17-year high.

“There’s now a wider range of potential outcomes for when rate cuts are going to come, and that sets up the potential for increased volatility as we head into year end,” said Josh Jamner, investment strategy analyst at Clearbridge Investments.

Even while betting against the hawkishness of the U.S. central bank has largely been a losing bet since policymakers started rising borrowing prices in March 2022, it suggested that at least section of the market was sceptical the Fed would hold steady on maintaining rates as high as it expected.

Late on Wednesday, futures linked to the Fed’s policy rate showed investors were betting the institution will loosen monetary policy overall by around 60 basis points the next year, pushing interest rates to roughly 4.8%. In contrast, the Fed had projected 5.1% in its revised quarterly projections.

“It looks as though the Fed is trying to send as hawkish a signal as it possibly can. It’s just a question of whether the markets will listen to them,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities USA. “If the economy starts to soften, I don’t think these dot-plot projections will actually hold up.”

According to many investors, the most important questions are how much the 525 basis point rate increases the Fed has implemented since March 2022 to combat inflation have affected the economy and whether or not the U.S. economy will continue to grow if rates remain at their current levels for the majority of 2024.

A “solid” economy, according to Fed Chair Jerome Powell, would enable the central bank to maintain further pressure on financial conditions at a significantly lower cost to growth and the labour market than in prior U.S. inflation conflicts.

The idea of an economic “soft landing,” where the Fed is able to gradually cut inflation without sparking a recession, is still under threat from a number of near-term dangers facing investors.

These include rising energy costs, the beginning of the autoworkers’ strike last week, the potential for a government shutdown, and the lifting of the student loan payback moratorium. Indicators of shaky growth could support the argument that the central bank should drop rates much sooner than anticipated.

“Inflation is going in the right direction, but … there’s a lot of headwinds” to growth, said David Norris, head of U.S. credit at TwentyFour Asset Management.

Bond rates, in the opinion of John Madziyire, senior portfolio manager and head of U.S. Treasuries and TIPS at Vanguard Fixed Income Group, are “super attractive” and close to reaching their top.

“I don’t think there’s much room for yields to go higher, so as a long-term investor … you should be adding more duration risk at these levels and use any selloff to actually add duration risk,” he said.

As stronger-than-expected economic growth led markets to reevaluate estimates for a 2023 recession and push back expectations for how soon the central bank would drop borrowing costs, betting on a rate peak has, of course, backfired on investors numerous times in the previous year.

But according to Norris of TwentyFour Asset Management, the longer rates remain high, the less likely it is that the story of a soft landing would come true.

“If they keep monetary policy as restrictive as it is … the chances of a harder landing become higher,” he said.

(Adapted from Nasdaq.com)

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