Hawks Rule the Roost at the Fed These Days

Going into Wednesday's interest-rate decision by the Federal Reserve, market sentiment was leaning toward a dovish hike, meaning that the U.S. central bank would raise rates but acknowledge some headwinds such as turmoil in emerging markets. What they got was the opposite, as policy makers said they still expect the economy to evolve in way that warrants “further gradual” rate increases.

In other words, the Fed expects to raise rates a total of four times this year, up from the three bumps central bankers had signaled back in March. If it wasn't evident before, it should be now that this Fed under new Chairman Jerome Powell intends to keep tightening monetary policy until, as East West Investment Management Co. market strategist Kevin Muir put it in a pre-decision blog post, something breaks. The question is, when will that happen? It's impossible to know, of course, but the bond market seems to suggest that such an event is getting closer. That can be seen in the yield curve, or difference between two- and 10-year Treasury yields, which shrank to less than 40 basis points following the rate announcement. The gap is the narrowest since 2007, and a growing number of strategists say it's likely to invert before much longer, an event that typically precedes a recession.