The Tr 21 trillion U.S. Treasury market has already advanced the article ahead of the Federal Reserve’s March 17 decision. The benchmark ten-year yield is at its highest level since January 2020, while the 30-year yield is at 2.44 per cent for the first time since August 2019. As Fed Chair Jerome Powell dared to stop them, bond traders are throwing another provocation. Instead, the Fed is adapting to its new framework. Yes, US economic growth will be strong this year and inflation will average 2% in the coming years. But sans proof, it does not bother the pencil at all in the interest rate hike.
As expected, the Federal Open Market Committee does not change the Fed Funds rate from 0% to 0.25% and does not file with its asset purchases. Fed officials updated their economic forecasts for the first time since December, showing economic growth of 6.5% this year and headline inflation at 2.2% in 2021, 2% in 2022 and 2.1% in 2023. The U.S. unemployment rate will probably fall to 4.5% this year, then 3.9% in 2022 and 3.5% in 2023, which is enough to cover the lowest set of generations in late 2019 and early 2020.
However, this is not enough to move the median forecast among Fed officials on the ‘dot plot’, which shows an estimate that the US Central Bank’s benchmark rate will be close to zero by 2023. Some policymakers have been hit by not two rounds of financial aid and extensive vaccinations: seven of them are expected to raise rates in 2023, five out of December, four of them starting in 2022, not just one.
Clearly, if the central bankers’ financial expectations are met, the dots will move higher. “Most of the committee did not show a rate increase during the assessment period,” Powell said. “Some part of it is just looking at the actual data at this point rather than just a forecast. We hope to get started. With the progress made with vaccines, make rapid progress in both labor markets and inflation as the year goes on, because of the financial support we get. We hope this happens, but we need to see first.”
Bond traders are not so patient. The reason Treasury yields have risen so much is that investors are worried about the pickup in inflation. Bond-fund manager Bill Gross said on Tuesday that he was betting against the long-term treasury and that inflation would reach 3% or 4% in the coming months. Greg Jensen, co-chief investment officer at Bridgewater Associates, said this week that “determining the price of inflation in markets is actually the beginning of a big global change, not overreacting to what’s happening.” This is exactly what the Fed wants to see what bond traders will not do. When Powell announced the central bank’s average inflation target framework last August, he lamented how difficult it was to raise the country’s collective expectations for future price increases after the fall years. 2% less.
Now comes the tricky part: actually observing inflation above 2% for a continuous period. Fed Vice Chair Richard Clarida suggested that inflation should remain at an average of 2% for the full year before raising interest rates, an obstacle never encountered since the 2008 financial crisis. Fed officials have made it clear that they expect to see outsourced figures in the coming months, which are not a reason to change their course. “I have observed that inflation growth of more than 2% is unlikely to meet this standard, as is likely to occur this year,” Powell said.
Powell was pressured into deviating from the Fed’s expectations of an interest rate hike in 2023. After all, headline inflation is projected to be at least 2% each year until 2023. “The state of the economy is very uncertain in two or three years and I do not expect to focus on the exact timing of the rate hike in the future,” he said. “The fundamental change in our framework is that we’re not going to act in advance based on most forecasts, and we’m going to have to wait to see the actual data. I think it will take time for people to adjust to it, and the only way we can really do that is to increase its credibility.”
With 10-year yields fluctuating between 1.68% and 1.62%, the Treasuries are caught up with this reality after the decision. In an effort to ease pressure on short-term rates, the central bank raised the daily counter-party limit on reverse repo operations, the first such increase since 2014. However it did not raise the interest rate on additional reserves. Bond traders may increase their long-term treasury yields in the coming days. But at least the initial market reaction suggests that investors are taking into account the fact that the Fed is going to run through some loud tricks.
Brian Chappatta Bloomberg Opinion columnist, covering the debt markets