The longer end of the US curve is composed ahead of tonight’s release of Fed minutes: with 10-years yields, around 2.88%, back to where they ended last week, after the spike to 2.94% when January’s inflation data came in slightly above forecast. The shorter-end yields continue to rise, however: with 2-year yields touching 2.28% - almost double the yield they offered 12 months ago and moving further into 9.5 year highs (contrastingly over a 12 month period 30-years yields have risen 10bp from 3.04% to 3.14%).
If tonight’s Federal Reserve minutes exhibit the usual long-term cautionary view on inflation data and there remains a clear split of opinion over the US economic outlook, one could see a tempering of the recent rate-hike-hype. The markets are exhibiting a 23% probability of 4 or more hikes this year with around a 32-36% chance for either 2 or 3 hikes (still with a 9% probability that this March’s hike will be the only one). Perhaps even more important will be discussion over any change of growth and inflation prospects - in light of the recent tax cuts. The minutes could either spook or reassure markets. But if the minutes show that the Fed is expectant - but comfortable - with inflation heading higher this should be a positive for bonds: given the market already sold-off in reaction to January’s Fed policy statement that inflation ‘is expected to move up this year’ and further tightening is already priced in. The minutes won’t, however, shed any light on the Fed’s view on the recent market volatility which happened after the FOMC meeting.
We were reviewing today that longer-dated Treasuries have outperformed shorter-dated in the last five tightening cycles - with the natural effect of higher rates (in due course) dampening both inflation and economic growth. And with the long-run dots plot implied Fed Funds Target Rate still at a modest 2.75% it seems unlikely there would be enough lasting shifts in forecasts to push the longer-end of the Treasury curve much beyond its recent highs. Global growth and inflation have of course picked up, and we continue to follow these indicators closely along with our model forecasts, but we still see a number of factors that should limit further upside in both of these. Either way, we do still expect some more Fed-related volatility than usual ahead: with digestion of these minutes followed by Fed Chair Jerome Powell’s testimonies to Congress next week.