The Federal Reserve yesterday repeated its intention to continue raising interest rates, and some investors actually believe it, which in turn inspires selling. But such running for cover isn’t universally embraced, at least not yet. The bond market, to name the conspicuous example, isn’t quite sure if it wants to take the Fed warning to heart.

The warning, such as it is, comes by way of Fed-speak in yesterday’s FOMC statement: “…the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.”
Expecting no less, yield-sensitive equities pre-emptively reacted. The Morgan Stanley Reit Index has suffered a sharp correction in recent days, although it rebounded a bit today. The Dow Jones Utilities Average too has been falling of late, albeit less sharply than REITs. Is this a sign that the rising short-term rates are set to lure assets away from yield-oriented equities in the weeks and months ahead?
Perhaps, although the bond market’s not yet convinced that rising short rates are a real and present danger for longer-dated maturities in the debt realm. Despite the 25-basis-point rise of Fed funds to 3.5% on Tuesday, the yield on the 10-year Treasury remained essentially unchanged today relative to yesterday’s close, and currently hovers at just under the 4.4% mark.
One theory making its way around the bond market is that the Fed, by raising short rates, will keep any inflationary pressures bubbling in check. One analyst goes so far as to note that with yesterday’s 25-basis-point hike behind us, there’s a relief rally underway in Treasuries. “With the Fed out of the way, there’s a little relief that they weren’t as hawkish as might have been inferred from recent data,” Gerald Lucas tells Bloomberg News..
The old advice not to fight the Fed is s-o-o-o yesterday. And not without reason, since fighting the Fed has been less-than-savvy advice for much of the last 14 months. When the central bank began raising Fed funds back in June 2004, a 10-year Treasury yielded nearly 4.6%. Despite Fed funds ascending to 3.5% yesterday from1% in June 2004, the 10-year Treasury yield has fallen slightly. Fighting the Fed, in sum, has been a profitable game—to date.
Still, Fed rate hikes were once considered bad news for the bond market. Today, rate hikes are said by some to be a sign that the Fed’s intent on keeping a lid on inflation. We can only guess what it will all mean tomorrow.