Fed sees rising bond yields and inflation expectations a possible victory

(Reuters) – A recent rise in U.S. bond yields and market inflation expectations have heightened hopes among Federal Reserve officials that the central bank’s new approach to monetary policy materializes and could be strengthened if a Congress headed by the Democrats is spending more.

“I am encouraged to see the rise in market indicators of inflation expectations. … This is what we are trying to support, ”Richmond Federal President Thomas Barkin said in an interview with Reuters on Thursday.

Barkin said he viewed a recent rise in interest rates on Treasuries as also part of a “reflation swap,” a sign that investors were factoring future price hikes into their decisions by demanding higher interest rates, rather than representing a worrying tightening of conditions.

“The ingredients for higher inflation are in place,” St. Louis Fed Chairman James Bullard said in separate comments to reporters. “You’ve put in place a very powerful fiscal policy and maybe more to come,” with Democrats on the verge of controlling the White House as well as the US Senate and House of Representatives.

“You have a Fed that … temporarily wants to have inflation above target. You have the economy about to explode at the end of the pandemic, “once the impact of the new coronavirus vaccines kicks in, Bullard said.

The benchmark 10-year Treasury yield surpassed 1.07% on Thursday, hitting its highest level since March. The expected 5-year inflation rate has reached almost a two-year high of 2.05%.

“ INCREDIBLY DISAPPOINTING ”

After nearly two years of study, the Fed changed its approach to monetary policy in August to allow for higher inflation, hoping to meet its target of 2% on average by letting prices drift higher for a while in order to compensate for years when inflation had been low.

This would also, in theory, allow a lower unemployment rate as the central bank would try to support the type of “hot” economy that drives prices up.

Massive uncertainty over the economy and the course of the pandemic at the end of last summer has since given way to what Barkin said was more “clarity” on the current situation – with two vaccines against the coronavirus distributed, tax buffers in place to help many US households, and consumers “close” to when they “will enter the economy with much more confidence.”

The pace of vaccine distribution will play an important role when this happens, with some policymakers expressing dismay at the efforts so far.

Philadelphia Fed Chairman Patrick Harker called the first vaccination figures for the United States, with less than 5 million vaccinated to date, “incredibly disappointing.”

But events of the past few weeks appear to have shifted the market’s bets on the future, with transactions in inflation-linked securities hinting that investors expect higher inflation and accept that the Fed will not do it. obstacle.

“We’re looking at a long period of time in which the fed funds rate will essentially stay at zero,” Harker said, referring to the central bank’s overnight key rate. He added that he saw no sign that “inflation was going to get out of hand.”

Indeed, Chicago Fed Chairman Charles Evans has expressed more skepticism about inflation to come, even with additional government stimulus that may be on its way to help combat the economic fallout from the pandemic. and the recession it triggered.

The surge in inflation from additional tax spending, he told a group of bankers Thursday, is not “as strong as I would like.” He said he believed inflation would not reach 2% until 2023 and that it would not be unreasonable for the Fed to wait until mid-2024 before raising short-term rates from their near current levels. zero.

San Francisco Fed President Mary Daly at an event hosted by the Manhattan Institute’s Shadow Open Market Committee on Thursday said she believed a stronger job market would eventually lead to higher inflation, although the upward push in prices from a tight labor market is likely. weaker than in the past, making a sudden surge unlikely.

This means, she suggested, that the Fed can allow the labor market to strengthen further than in the past.

At the same time, Daly said he was reassured by a pickup in inflation expectations, which showed market participants, households and businesses are starting to believe that the Fed will meet its target of exceeding inflation by 2. %.