By JAMIE MCGEEVER
ORLANDO, Florida- If signals from the US bond market prove accurate, the Fed will be successful in getting inflation down to a ‘2 handle’. Just not its 2 percent target.
Moves in bond yields, implied inflation breakeven rates, and inflation-adjusted ‘real’ yields suggest investors anticipate the Fed’s ‘higher for longer’ interest rate policy will help lower inflation to around 2.5 percent .
The moves currently underfoot in the bond market are dramatic. But this is not a re-pricing of the Fed’s near-term trajectory, rather a repricing of the longer term economic and inflation outlook.
Annual consumer price inflation around 2.5 percent could legitimately be considered a success – it was 9 percent in June last year – especially if the hallowed economic soft landing is achieved and a painful recession is avoided.
Policymakers would probably bite your hand off for that scenario but never admit it. They will insist policy be set to get inflation down to 2 percent which, crucially for markets, implies there will be no easing, as investors had long expected.
“The risk of inflation staying higher than where we want it is the bigger risk. We ought to have 100 percent commitment that we’re going to get inflation back to target,” Chicago Fed President Austan Goolsbee told CNBC on Monday.
This suggests the Fed is entering a phase of structurally higher rates than perhaps policymakers themselves, and certainly investors, had anticipated.
What is curious about this is the bond market appears to accept that the economy will remain relatively hot and policy will stay restrictive for longer, yet is unconvinced inflation will get down to 2 percent .
Many analysts are skeptical that moves in bond yields can be broken down, quantified and compartmentalized with any great degree of accuracy. There are too many moving parts, especially further out the curve.
But interest rate strategists at Goldman Sachs have tried to break down what is behind the selloff in 10-year bonds over the last couple of months that has driven yields up more than 50 basis points to a 16-year high above 4.50 percent.
They attribute just under half of the rise to ‘policy’ – investors are finally realizing that the Fed is in for the long haul on higher rates – and about a third to stronger ‘growth’. ‘Inflation’ and ‘residual’ – essentially increased supply – account for a fraction of the increase, they estimate.
This fits with what inflation breakeven rates and real yields have shown in recent weeks – shorter-dated rates drifting lower and longer-dated rates rising.
