Investors polled don’t see the Fed navigating a soft landing

Investors are skeptical about the Federal Reserve’s ability to rein in the worst inflation in four decades without plunging the economy into a recession.

That’s bad news for Americans, who face the prospect of a downturn as their food, rent and fuel bills rise. But for bond investors hit by heavy losses this year, it could mean any further pain will be short-lived as a recession prompts the US central bank to cut rates next year. This is according to the results of the latest MLIV Pulse survey.

More than 60% of the 1,343 survey respondents said there was little or no likelihood that the U.S. central bank could contain consumer price pressures without causing an economic contraction. The survey was conducted from July 18 to 22 with individual and professional investors.

“It’s uncertain whether the Fed will be successful in fighting inflation, because it’s a very difficult task,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “I don’t think the Fed will ignore the growing risk of recession, but at the same time they are focusing on inflation. So I’m still bearish on Treasuries – but we’re probably in round eight on the upper bound of yields.

About two-thirds of MLIV Pulse respondents expect the 10-year Treasury yield to peak over the next nine months at less than 3.7%. A move up from this zone would of course be difficult for bond bulls, as the yield was trading around 2.81% as of 7:48 a.m. Monday in New York. Still, this maximum expected return isn’t far off the 3.5% peak seen in June, so the overall losses wouldn’t be much worse than what was felt last month.

The rapid revaluation of financial markets this year, as the Fed withdrew pandemic-era stimulus, caused the 10-year yield to nearly double from March to mid-June. That pushed a broad gauge of Treasuries to a loss of nearly 12% as of June 14, more than triple the record low of 2009, according to Bloomberg data dating back to 1973.

But the bond market has since rebounded, with yields falling sharply on Friday after data showed a contraction in business activity in the United States for the first time since 2020. Overall, yields fell last week due to speculation that tighter financial conditions are slowing growth. This would ultimately cause the Fed to stop tightening and ease monetary policy next year. These views were reflected in the MLIV survey, which found that most believe the Fed will begin cutting rates in 2023.

Ahead of that, a majority of those polled doubt the Fed will step up the size of its rate hikes, despite some speculation that it will opt for a full percentage point hike as early as the July 27 meeting. Most expect the Fed to maintain a maximum velocity of 75 basis points per meeting, in line with the June increase that pushed its benchmark target rate into a range of 1.50-1.75%.

The funds rate will peak at 4% or lower, in line with Fed officials’ quarterly forecast range, the majority of survey respondents said. Some 26% of investors opted for more than 4%. And at the lower end of the range, about 8% said it would be 3%.

Yet inflation is expected to remain high: more than 50% of survey respondents see the Fed rate below inflation when it peaks. This shows the anticipation that the Fed would tolerate higher-than-usual inflation rather than continuing to raise rates during a recession.

Robert D. Coleman