Chart of the week
In the days immediately following the Fed’s weekly meeting on 16 June, markets were volatile and the US yield curve twisted. While yields on short-dated US treasury notes (one month to one year) hardly moved, intermediate yields (two to five years) rose significantly and yields on the longest maturities (10, 20 and 30 years) fell sharply.
In the short term, the Fed is not expected to increase interest rates, which explains the relative stability in the short end of the yield curve. However, the dot plot, which displays the FOMC members’ policy rate projections, did not go unnoticed. A growing number of members are now expecting a rate increase in 2023 and their median forecast for the year has climbed from zero to two increases. That was all it took for yields on notes with maturities between two and five years to rise.
Logically, this upward pressure should have also led to a rise in long-term yields, which are still extremely low. Instead, they fell, almost as if the market were pricing in a future normalisation of monetary policy and excluding any impact on long-term yields from a scaling back of the central bank’s asset purchase programme. Yet the Fed has always made it clear that rates will be increased once purchasing has been scaled back.
One possible explanation is that investors believe the Covid-19 crisis has pushed down equilibrium interest rates, as did the 2008 financial crisis. In this case, the Federal Reserve would raise rates but less than previously, effectively anchoring them at lower levels. However, the Covid-19 crisis differs in many ways from the last recession and not least in terms of government spending, which is set to increase significantly if the Biden administration’s budget proposal is anything to go by.
A simpler explanation may be that the shift is part of a market correction driven by investor positioning and the fact that many had started anticipating higher rates. Things will become clearer in the months ahead.
The following opinion was written on June 21th 2021 and is susceptible of changing.
Sources :Bloomberg and Lazard Frères Gestion, June 21th 2021
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