Fed Inflation Credibility Test Sparks Market Turmoil

The recent policy meeting of the Federal Reserve has raised questions about its control over the bond market. US economists say that the market is testing the Fed's inflation credibility, with higher long-term yields limiting support for the US Dollar.

Bank of America described the move as consistent with an 'inflation credibility shock', where markets question the Fed's ability to control inflation. The bank noted that the nominal and real UST curves have sharply twisted steepened since the meeting.

The reaction to the meeting was uncomfortable enough to raise concerns about the Fed's control over the bond market. Short-dated Treasury yields fell as markets reduced expectations for near-term rate hikes, while longer-term yields moved in the opposite direction.

Natixis is less certain that matters have gone this far, arguing that two trading sessions are not enough to conclude that the Fed has lost its credibility. However, Natixis admits that the market reaction 'does smell like 2022', referencing a period of similar market turmoil.