The bond market received a reality check this week as the Federal Reserve delivered a message that sent shivers through investor expectations. This Wednesday, the fed has announced that they have made a significant policy move. Finally, announcing the first interest rate cut in years as inflation shows signs of easing.
As per the facts, bond prices and interest rates have an inverse relationship. When interest rates increase, bond prices decrease, and vice versa. Older bonds with higher interest rates become more valuable. Existing fixed-rate bonds decrease in price.
The central bank reduced its benchmark rate by an unusually large half-percentage point, to between 4.75 and 5 percent.
Federal Reserve Chair Jerome Powell also signaled that the central bank may keep interest rates steady longer than expected, even as inflation shows signs of easing. This unexpected stance challenged the bond market, which had been betting on rate cuts as economic growth slowed, and recession fears mounted.
Additionally, the bond market had been anticipating a recession and expecting the Federal Reserve to cut much bigger interest rates. They were surprised when the Fed signaled it might also keep rates high for longer. This caused bond yields to rise sharply as investors adjusted to the possibility of higher borrowing costs for a longer period. Also creating confusion for the investors.
The central bank’s stance suggests that it is still focused on controlling inflation, which changes the outlook for the bond market and overall economy.
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