The Federal Reserve’s next interest rate increase will mark a key milestone as the era of cheap dollars draws to a close, further unsettling a U.S. bond market already rattled by rising inflation and government debt supply.
Next Wednesday the U.S. central bank will likely raise key overnight borrowing costs to roughly match its target for inflation, meaning that for the first time in almost a decade the cost of borrowing dollars will no longer be essentially free.
“We are looking at a tipping point now that inflation is rising,” said Bill Merz, head of fixed income research at U.S. Bank Wealth Management in Minneapolis.
U.S. overnight borrowing costs are in a range of 1.50 percent to 1.75 percent, with traders largely expecting the Fed to raise that target by a quarter of a percentage point next week. The Fed’s target rate has been below its 2 percent inflation goal ever since the 2007-2009 financial crisis.
Some analysts cautioned the rate increase would unsettle the bond market by pushing short-term borrowing costs to levels that will make some trades less appealing, such as carry trades using cheap loans to buy high-yielding securities and so-called curve flatteners selling short-dated debt and buying longer-dated issues.
“It’s always rising short-term rates that cause problems in the credit and other risky assets,” said James Camp, managing director of fixed income at Eagle Asset Management in St. Petersburg, Florida.
Higher short-term borrowing costs would likely have more sustained consequences for traders and investors than a recent spike in benchmark 10-year Treasury yields, Camp said.
SHORT-TERM RATES PUSHING HIGHER
The combination of Fed rate hikes and more federal borrowing will likely make it less profitable for traders and more expensive for U.S. companies to borrow, analysts said.
And last year’s U.S. tax code overhaul has increased the competition for dollars from foreign banks as U.S. multinational corporations began bringing their overseas cash back home, particularly from Europe, at a lower tax rate.
Reference: Reuters
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