The path of least resistance is still for a steeper Treasury yield curve

The dot plots yesterday were less hawkish than anticipated, with no median rate hike penciled in for 2023 and that saw Treasury yields fall - with the short-end of the curve in particular seeing yields decline more rapidly than the long-end i.e. steepening.


This comes despite positive revisions in the Fed's economic forecasts and more notably, with PCE inflation set for 2.1% in 2023. In other words, the Fed is really trying to stick with the view that it is going to let inflation run rather hot before hiking rates.

That said, the communication mix by the Fed on the two factors above failed to really spook rates pricing. Eurodollar futures still roughly see a rate hike occurring on March 2023, with three rate hikes priced in for that year - similar to before the FOMC yesterday.

Powell didn't really outline any uncomfortable feelings on the latest bond market developments, so the key takeaway is that things are likely to follow the theme of 'steeper for longer' until the Fed provides more clarity on when it may hike rates.

There was nothing in it for the hawks yesterday as Powell & co. went all out to communicate an extremely dovish message to the market, even not debating the SLR exemption situation and leaving that decision for "the coming days" instead.

But essentially, this demands more of the market - particularly the long-end - to price in future inflation developments before the short-end will really react.

As such, expect a steeper yield curve in Treasuries to continue in the months ahead.

As for the dollar, even if the short-end isn't quite moving yet (no immediate pre-taper tantrum move), the impact of higher yields in the long-end and more bullish US economic prospects could very well limit any material downside move.

Of course, the pace of the move is arguably also an important factor to consider.