The bad smell of inflation

Karsten Junius March 31, 2021 11:00

The Fed said it would give advanced warning to the market with regard to the tapering of bond purchases. Photo: Reuters

Although the adjustment to a more normal rate structure in the US has progressed considerably, the risk remains that bond yields may move somewhat higher in the coming months as inflation concerns and uncertainty regarding Fed policy lead to a steeper yield curve. Risk markets are not behaving in a disorderly manner for now, and the Fed is, thus, unlikely to push back against the recent back-up in yields in the near term.

The Fed has doubled down on its stance of leaving rates unchanged throughout 2023, although there is a shift to a slightly more hawkish stance beneath the surface. Updated forecasts show a substantial upward revision to growth expectations, although inflation forecasts (core PCE) were left practically unchanged at 2.0% for 2021 and 2.1% for 2022, implying the Fed will look through rising inflation readings over the coming quarters as it considers them transient. With regard to the tapering of bond purchases, the Fed chair has again stressed that the Fed would give advanced warning to the market. Therefore, tapering is unlikely to happen before 2022.

An accelerating US economy, accompanied by rising concerns about inflationary pressures and a Fed perceived to stand put for an extended period of time, continues to be a recipe for a steeper curve as market participants demand a higher risk premium for long-term maturities. US 10-year break-even rates are still well below the 2.5% band where they usually turned in past cycles, and they probably have some more room to rise. The front-end of the Treasury yield curve should do better as some of the near-term bets on rate hikes will likely fade after Powell’s comments. Consequently, we would expect the 2y/10y and 5y/30y to steepen further.

As we have forecasted before, there are upside risks to our forecast over the next few months. Although the adjustment to a more normal rate structure has progressed considerably, there is a risk that bond yields may move somewhat higher over the coming months as inflation concerns and uncertainty with regard to Fed policy lead to a steeper yield curve. Markets are sounding out the Fed’s pain threshold for nominal and real rates.

-- Contact us at [email protected]

Karsten Junius

Chief Economist, Head Economic Research at Bank J Safra Sarasin

Hong Kong

Smart prison to address challenge of high staff turnover Dr. Winnie Tang

The Correctional Services Department (CSD) has faced numerous challenges in recent years, including ageing facilities, serious staff turnover. To overcome these challenges, one must start from

No church in the wild Brian YS Wong

A recent uproar over the government’s ostensibly wanton killing of wild boars – has rocked the city. The uptick in number of altercations between boars and humans has prompted the administration to

Covidiocy Neville Sarony

It really is time for the adults to impose some basic common sense in the kindergarten that poses for a government. Where in the world would you have a major institution run by the inhabitants of the

Enriching local talent pool key to innovation Dr. Winnie Tang

To make Hong Kong an innovation hub, the government has invested more than $130 billion. In addition, in this year’s Policy Address, the Chief Executive also mentioned the annual quota of the Quality

Will TVB ever return to its glory days? Ben Kwok

A Chinese proverb said, “Thirty years on the east bank of the river, and thirty years on the west bank of the river”, meaning things are constantly changing and over the long run, it's almost certain