Markets putting Fed normalization bets back on the table

Brushing through the initial risk selloff in equities, positive sentiment was generally intact post the FOMC release. US equity indices ended sharply higher alongside UST yields. Interestingly, the market is viewing the Fed to be hawkish with market rates putting a slightly higher probability to December liftoff (the implied Fed funds rate is up by 2bps to 0.19%). The implied rate for end-2016 was more sensitive, rising by 9bps to 0.68%. Overall, the pace of normalization as anticipated by the market remains slow (50bps/year).

The intermediate segment of the UST curve was the most sensitive to changes in Fed expectations. In particular, 2Y (up by 8bps overnight) to 5Y (up by 10bps overnight) USTs are likely to be most vulnerable once liftoff becomes imminent. Curve flattening in the 5Y/10Y and the 10Y/30Y segments are likely if Fed normalization takes place under a modest inflation backdrop. Meanwhile, WTI prices registered a rebound (up by over 6% overnight), albeit from very depressed levels. Oil prices have been volatile within the USD 40-50/bbl over the past two months. Stabilization on this front would be needed to anchor inflation expectations and bring the UST curve higher.