A hawkish Federal Reserve won’t deliver bullish hikes

The Federal Reserve’s tilt toward a more hawkish stance under Governor Kevin Warsh has revived debate on “bullish rate hikes” – episodes where tightening cycles coincide with falling bond yields. While history does provide evidence of a few cases, we find little basis for optimism this time around.

What you will learn:

• Bullish rate hikes happen under a narrow set of conditions, when a central bank tightens aggressively in an economy where prices and wages adjust quickly to inflation shocks. That combination fits emerging markets much better than the US.
• We flag a genuine cautionary signal, though: US inflation has grown stickier since the coronavirus pandemic, and growing importance of past inflation and expectations on current price-setting could create a dynamic that pushes the Fed toward more rate hikes.
• Even if bullish hikes were likely, other yield drivers would put upward pressure on long-term rates. Fiscal profligacy and AI productivity could drive yields up by much more than what our most optimistic estimates of cyclical hikes ever could.