With its gradual deterioration set, the Fed faces its toughest task yet: Morning Brief – News Couple

With its gradual deterioration set, the Fed faces its toughest task yet: Morning Brief

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Thursday 4 November 2021

No tapering tantrum in sight, price hikes take center stage

On Wednesday, the Federal Reserve passed its first major test – announcing the slow normalization of policy without upsetting the markets. By announcing that it would limit bond purchases as growth slows and price pressures exacerbate, markets responded by setting new records – suggesting that the central bank walked a tightrope without falling out.

Wall Street economists lauded the Fed’s communication skills, which at least didn’t spark a “taper tantrum” similar to what happened in 2013, when markets were turbulent over the proposed withdrawal of monetary stimulus.

However, by all indications – a spike in inflation that central bankers insist is “temporary” (the economists of course think otherwise) – the Fed’s hard work in managing market expectations is just beginning.

While stocks welcomed the Fed’s announcement, bond markets are sending a slightly different story. After the Fed’s decision, short-term US Treasury yields soared, with the one-year yield at 0.170% — the highest level since mid-June 2020, according to Tradeweb data.

One-year US Treasury yield: March 2, 2020 – November 3, 2021

Short-term government papers are the most sensitive to inflation and central bank projections, and investors active in this particular part of the curve seem to believe that Fed rate hikes will come faster than some expect.

And so Wall Street begins its newest parlor game: when and how prices will inevitably rise.

While the central bank’s median forecast expects three to four hikes by 2023, a few players on Wall Street are beginning to suspect that higher rates will eventually force the Fed to do so. As the economy loses momentum, higher rates may roll across a wide range of borrowing costs such as bonds, credit cards and mortgages at the worst possible time.

According to Wall Street veteran Peter Bokfar, “The Federal Reserve now has three professors, the US Treasury, the bond and stock markets, and their officially defined market, inflation and the job market. Thus, their progressive mantra will be in order to try to please everyone as always when it comes time to tighten up. policy and they are unlikely to deviate from what is expected.”

Fed Chair Jerome Powell said in a research note that Fed Chair Jerome Powell’s comments “reiterate his desire for the Fed to remain patient as long as inflation allows, but position himself to respond if price pressures are surprised, especially in light of market dynamics.” Current unique work. Wednesday.

“In general, we remain comfortable with the view that the first rate hike will come at the end of next year, in the fourth quarter,” the bank added. “However, in the event of strong and persistent inflation, and thus a reassessment of maximum employment, the risks will be pushed forward.”

Interest rate trend, US vs. the world (excluding China)

Interest rate trend, US vs. the world (excluding China)

The utterances here are “stronger” and “continuous inflation,” which is how a host of companies, CEOs and especially consumers feel, no matter what bond yields do.

Franzisca Palmas, market economist at Capital Economics, thinks the rise in short-term bond yields looks “exaggerated” and that long-term interest rates will start to rise again.

However, there is a growing lack of conviction among some economists about how much tolerance the Fed can tolerate building up inflationary pressures, which is showing little, if any, signs of abating.

We believe that delaying tightening on the back of still relatively high inflation should build expectations for further hikes in the future. We believe this impact will be the largest in the US, where we expect inflation to decline less than many expect due to strong core inflationary pressure and the Fed’s willingness to take inflation above target.”

Let the chicken game begin. But who will emerge victorious: bond investors, or the Federal Reserve?

by Javier E David, editor at Yahoo Finance. Follow him in Tweet embed

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