At times in the QE era, the markets have rushed to adjust to a rapidly evolving understanding of the Fed’s policy intentions. At other times, the Fed simply surprises the market with a new reality that can’t possibly be priced in all at once. Nonetheless, the need to price it in is apparent. The result is a relentless series of rallies or sell-offs that seem to be overdone. They only begin to make sense when we step back to consider the bigger picture, and that bonds couldn’t possibly go where they think they need to go in one quick move. We refer to this process as “repricing.”
The moves on the chart below may look “quick, but by far and away the shortest example was the repricing that took place after Trump was elected. That lasted a month and a half even though the bond market was trading an event that occurred in a single moment. In that sense, the election should be a shorter-term repricing. Contrast it to a shift in Fed policy, which typically plays out over several weeks of Fed speeches, announcements, dot plots, and congressional testimony.
As for a more quantitative measure of repricing, how about Fed Funds Futures? The following chart shows futures contracts for the end of June, September, and December 2022. Notably, last week’s Fed hike was the only one the market expected for the entire year last fall. As recently as early January, the blue line only suggested 3 hikes in 2022. The Ukraine war took almost 2 hikes off the table by early March, thus setting us up to price in FOUR additional hikes in just over 2 weeks. This is precisely why bonds have tanked so hard in the past 2.5 weeks. Or rather, it lines up with the associated losses. The deeper “why” has to do with inflation and the Fed.