Rates rising for 'good reasons' but don't fight the Fed Rates rising for 'good reasons' but don't fight the Fed http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\federal-reserves-small.jpg March 16 2021 February 25 2021

Rates rising for 'good reasons' but don't fight the Fed

Powell reaffirms commitment to easy money policies to support still-young recovery.

Published February 25 2021
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The recent run-up in intermediate and long-term U.S. Treasury yields has many worrying about how much higher they may continue to rise. The 10-year Treasury is up about 50 basis points this year and is nearing our 1.50% “soft” target for year-end. What has driven this rapid repricing? Accelerating Covid-19 immunizations will unleash pent-up demand for hard hit services (e.g., entertainment, travel and hospitality), boosting the economic recovery. In addition, the massive fiscal intervention related to the pandemic continues to grow as Capitol Hill Democrats are set to use the budget reconciliation process to pass President Biden’s $1.9 trillion Covid relief package without bipartisan support. These two forces—a further reopening economy as the threat of Covid fades and more debt-financed federal spending—are fueling expectations of strong U.S. growth, rising inflation and higher Treasury yields.

That said, a powerful countervailing force cannot be ignored. As Chair Jerome Powell affirmed this week in testimony before Congress, the Fed remains firmly committed to holding short rates at zero for the foreseeable future and to expanding its balance sheet at a massive pace of $120 billion per month. Policymakers have further signaled they’re willing to push those purchases further out the yield curve if long yields rise enough to threaten the recovery and the healing labor market. Near term, inflation may rise on base effects as we lap the deflationary shock of the Covid onset in March 2020, sending major inflation indexes toward or even temporarily above 2% on a year-over-year basis in coming months. Chair Powell, however, remains dismissive of suggestions a permanent breakout is on the horizon, saying that inflation dynamics generally do not “change on a dime” and that “the economy is a long way from our employment and inflation goals.”

To be sure, as reflected by rising inflation risk premiums in the bond market, inflation seems to be simmering with the potential risk of boiling in years to come. The Fed spent decades fighting inflation until it got too low. Are we now on the other side of the coin, with a Fed firmly committed to boost low inflation to the point it may end up getting a bit too much of it? Time will tell. Risk assets have wavered lately on concerns long rates may be setting up for an upside surge, while the Fed’s commitment to keeping rates in check has not wavered. Until that dynamic changes, we’re reminded that it rarely pays to fight the Fed in the short term. In sum, Federated Hermes fixed-income duration committee continues to position for a bias toward higher rates on fiscal and economic expansion, although the Fed’s push back seems likely to slow the pace and magnitude of further increases in the near term.

Tags Interest Rates . Monetary Policy . Markets/Economy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

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