The bond market has an expectation that the Federal Reserve will prevail over rising inflation.
Everything points to demand for protection against inflation on TIPS becomes less and less popular. TIPS yields are at 2.6% right now, down from a peak of 3.76% in March 2018. In terms of the markets, there is still a significant margin between the expected peak Fed rate and 4%. Long-term Treasury yields have risen significantly but this is not enough to say it would lead to a recession.
“If inflation comes down to what the markets are targeting, a soft landing is possible.” Said Rick Rieder, the Chief Investment Officer of Global Fixed Income at BlackRock Inc., the world’s largest asset manager.
TIPS are a type of Treasury securities that have a fixed payment with an adjustment for inflation. These bonds have the lowest possible risk when it comes to market fluctuations and investors can offset their losses should interest rates rise.
While commodity price trends helped explain the lower breakeven inflation rates, longer-term TIPS break evens have been rising and have actually reached levels as high as 2.5%.
That’s a vote of confidence in Fed officials including Chair Jerome Powell, whose latest public comments Thursday emphasized the importance of not allowing high inflation expectations to become entrenched with consumers. “The clock is ticking” on keeping inflation low and making sure that doesn’t negatively impact consumer sentiment.”
Powell’s comments seem to suggest the next interest rate hike on September 21st, bringing the total amount of tightening since March to three figures.- speaking Friday, also backed a larger hike. Fed officials customarily refrain from commenting during the week preceding a scheduled meeting, a period that has begun.
Until late August, markets were valuing the odds of an interest please increase at 50 percent, based on traders of Treasury securities.
The August inflation data needs to be weaker than currently expected in order to convince markets of the need for an even smaller increase. If the July inflation rate was 8.5%, and we have reason to believe it will continue decelerating,
Even with swap rates assigning a bigger chance to a September rate rise, the expected peak in the Fed’s policy rate in March 2023 stayed below 4%. The yield curve is pricing in a quarter point rate cut for the end of 2023. However, it was just last month that it priced in a 50th of a point.
This week’s increase in US 10-year bond yields has seen the 30-year bond exceed 3.51% for the first time since 2014. Whilst this is a longer term indication of an economic slowdown, it lessens the chance of a recession in the short term as firms could be swayed to invest aggressively.
The upcoming monthly auction of 3, 10, and 30-year Treasuries will create upward pressure on yields; however this may eventually fade. Next week brings two releases for the global markets – a retail sales report on Thursday and a measure of inflation expectations from the University of Michigan on Friday.
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