Bond market indicates room for Fed to raise rates without halting economy

Economy News


The US government bond market suggests that the Federal Reserve will be able to raise interest rates to curb inflation without swaying growth in the world’s largest economy.

Real returns, the returns investors can expect to earn after taking inflation into account, have jumped sharply in a sign that traders expect the US economy to continue to expand in the coming years, even as policymakers withdraw stimulus measures to intensify price growth delayed.

The yield on 30-year Treasury Inflation-Secured Securities (Tips) – a power of attorney for the real yield on the 30-year Treasury bonds – broke above zero for the first time since June 2021 on Friday. It closed at minus 0.47 per cent last year, according to Bloomberg data.

Investors said the rise in real yields and relatively anchored inflation expectations indicate that the Fed is well placed to tighten monetary policy without halting the recovery from the pandemic.

“The Fed’s control over the economy has just increased,” said Robert Tipp, head of global securities at PGIM Fixed Income.

Line graph of yields on inflation-protected treasuries (%) showing that US real yields have risen

The market movements were a recognition of the strength of the US economy and the strong outlook, according to investors.

In 2021, the U.S. economy recovered from the historic pandemic-induced recession by growing at the fastest annual pace since 1984. Vaccines, a return to work and strong federal stimulus all reinforced the recovery. But until recently, this was not reflected in the treasury market.

“Real rates were only absurdly low compared to economic fundamentals. So it only makes sense for them to rise, ”said Gregory Whiteley, portfolio manager at DoubleLine Capital.

Friday’s much stronger-than-expected job data was just the latest in a series of indicators to illustrate this recovery.

The closely watched U.S. payrolls report showed that the economy added 467,000 jobs last month despite the recent increase in Covid-19 cases. It also included a substantial surprise upward revision in employment figures for November and December, and showed that wages grew by more than expected.

The market responded by raising yields on U.S. treasuries, with the 10-year yield reaching its highest level since January 2020.

The strong job report could have driven inflation forecasts higher: more jobs and higher wages give workers more money to spend, which increases demand for goods that are scarce due to supply chain problems.

Instead, traders have merged around the view that the Fed has more room to raise interest rates and cool the economy. Market benchmarks of inflation expectations for five, 10 and 30 years in the future, known as break-even rates, have remained largely stable.

As a result, they ended the week by raising their estimates of how many times the Fed would tighten policy this year to five quarter-point rate hikes, from between four and five a day earlier.

Line chart of US break-even inflation rates (%) showing market benchmarks of inflation expectations declined

“Either the whole inflation market did not get the memo or they got the memo and the memo says that inflation will return to normal by the end of the year,” Chris McReynolds, head of US inflation trading at Barclays, said on Thursday.

Returns on longer dated break-even points are “very well controlled. “There is no thought of sustained levels of inflation,” he added.

Real rates are still suppressed by historical standards: the yield on five- and 10-year Tips notes remains below zero. Without further movement in real rates – or without a shift in inflation expectations – yields on traditional Treasury bonds could remain low, even as the Fed raises interest rates.

Although the rate at which consumer prices are rising is expected to reach a new high of 40 in January, there is some evidence that momentum may finally start to flag.

Economists polled by Bloomberg predicted that core consumer inflation, which removes the effects of volatile energy and food sectors, will rise at a slower pace in January than in December. Barclays economists have cited moderation in the price pressure on clothing and on used cars for the expected shift.

“I believe that the Fed missed the whole inflation thing, that they insisted for too long that it was temporary. But that was the 2021 scenario, ”said Andy Brenner, head of international fixed income at NatAlliance Securities. “I do believe that inflation will decrease.”



Source link

Leave a Reply

Your email address will not be published.