In the last FOMC meeting on May 3rd, the Fed raised its benchmark federal funds rate by a quarter point to a new target range between 5% and 5.25%. Another rate hike in the June 13-14 FOMC meeting would bring the federal funds rate to a 22-year high.
It will be a close call as to whether the central bank will continue to raise interest rates, skip, or pause.
Many economists believe the Fed will continue to raise rates until there is concrete evidence that inflation is moving down toward the 2% objective.
The Fed will review economic data and credit markets over the next few weeks to help determine if they will need to raise interest rates beyond the current target range.
The regional banking issue, credit conditions, and the debt ceiling debacle have introduced a new twist to the Fed and financial markets. The Fed will need to factor these conditions into its decision-making process.
If history is a guide, the Fed will continue to hike rates until it has tightened too much. When the Fed eventually cuts rates, it will again fall behind the curve as it has done so in raising rates in 2022.
From a trading perspective, it is critical to closely monitor the 10-year U.S. Treasury yield (TNX) to determine the market’s reactions to the Fed’s actions.
The U.S. Ten Year note diverging from the Fed Funds rate suggests many fixed-income traders are beginning to factor in a slowing economy that can slip into a recession instead of worrying about rising inflation.
TNX peaked on 10/21/23 at 4.333%. From October 2022, a well-defined downtrend channel has developed between 3.19% and 3.94%. The bottom of the downtrend channel also coincides with the 61.8% retracement (3.214%) from the Aug-Oct 2022 rally, providing significant support.
The recent short-term breakout above 3.5-3.64% (50-day ma, 200-day ma, middle of the downtrend channel, and the mid-Mar and Apr 2023 highs) warns at a near-term rally to retest the top of the downtrend channel (3.94%) and the 3/2/23 high (4.091%). Breakout above 4.091% is technically significant as this extends the TNX rally toward 4.333% (10/21/23 reaction high) and above this 4.69% (Sept/Oct 2022 channel breakout target) and 4.929% (head/shoulders top breakout target).
Since Dec 2022, a small head and shoulders top quietly appeared. The head is 4.091% (3/2/23 high), the left shoulder is 3.904% (12/30/22 low), the right shoulder is 3.629%-3.644% (3/22/23 and 4/19/23 highs), and the neckline is 3.19-3.253 (4/6/23 lows and bottom of the downtrend channel). Convincing moves above 3.905% (12/30/22 high or left shoulder) and 4.091% (3/2/23 high or head) reverse the downtrend channel and hint at higher rates.
On the other hand, a decline below 3.19-3.253% confirms a downtrend channel breakout and hints at lower rates toward 2.91% (78.60% retracement from Aug-Oct 2022 rally) and below this 2.35-2.525% (8/2/22 reaction bottom, Sept/Oct 2022 head and shoulders breakdown target, and the channel breakdown target).