The Fed changed its posture on interest rates in its June Federal Open Market Committee meeting. Several participants in the committee tilted hawkish indicating that they now expect interest rate hikes sooner than 2024.
The reaction from the market has been somewhat confusing. For instance, the US 10-year notes yield has been trending lower, the opposite of what you would expect when rates are expected to rise. TED spreads (the difference between the three-month Treasury bill and the three-month LIBOR based in U.S. dollars) have also compressed and are currently at historical lows as illustrated in the graph below. The spread tends to widen when credit conditions are expected to come under pressure. The contraction in the spread suggests that investors are happy with the credit conditions despite the fed aggressively drying up liquidity by selling reverse repos in the market.
Investors seem to be brushing off the Fed’s hawkish tilt, pushing the accommodative narrative forward. Perhaps investors are not expecting the bank to be aggressive and hence see rates remaining below historical average for a long time. The monetary policy is expected to remain accommodative for longer, albeit with interest rates slightly higher than where they are now. With such investor behaviour at play, we see SA government bonds benefitting despite reaching fair value.