Futures Now

Bond market will suffer some 'indigestion' as Fed prepares to charge, market watcher says

A 'bumpy ride' for bonds with Fed likely to signal more hikes

The Federal Reserve is expected to give the signal for more rate hikes later this year as it wraps its meeting on Wednesday.

The bond market is still struggling with that concept, says Bryce Doty, senior portfolio manager of fixed income at Sit Investment Associates.

"It's going to be a bumpy ride," Doty told CNBC's "Futures Now" on Tuesday. "Regardless of how well [Fed members] communicate what they're going to do, it's going to be kind of a spicy year. There's going to be some indigestion."

The bond market has already seen some twists and turns in 2018 as the Fed emerged as a more hawkish decision-maker under its new chairman, Jerome Powell. The yield on the 10-year Treasury topped 3 percent last week for the first time in four years on the expectation of higher inflation and a faster pace of Fed rate hikes.

Although no hike is expected at this meeting, Doty says the Fed still has an important role to play when it makes its midafternoon announcement.

"Their job [on Wednesday] is to try and remove any lasting impression that the Fed is going to pause or somehow slow their pace of increasing rates," he said.

Beyond May, Doty sees the Fed with little choice but to continue on its path of rate hikes this year, whether the market likes it or not. The Fed can already declare victory in fulfilling its dual mandate: the personal consumption expenditures price index, the Fed's preferred measure of inflation, is at its target level and the labor market is tight.

"How do they not say 'Yeah, we've achieved our inflation target of 2 percent?' And they've already said that they've achieved their target of full employment," said Doty. "It seems like the message is going to be: 'We've done our job.'"

The Fed last increased rates at its March meeting. The markets are currently pricing in another 25-basis-point hike to the fed funds rate at the June meeting, according to CME Group fed funds futures. Another should come in September, while a December rate hike is a toss-up.

Expectations of a fourth rate hike increase this year should rise following Wednesday's announcement, predicts Doty.

"You've seen the expectation for four rate increases for the year climb steadily from just a few weeks ago. It's over 50 percent already and that'll probably move even higher" following Wednesday's meeting, he said.

Bonds could react in one of two ways to that kind of message, says Doty.

"The 10-year yield could easily pop up over 3 percent or it could go down and just be relieved that they're going to be vigilant against inflation," he said.

The yield on the 10-year Treasury note was at 2.99 percent Wednesday morning.

Bond markets will have a bad case of 'indigestion' as Fed preps for more hikes