Explaining interest rates’ mysterious reaction to Fed policy   Explaining interest rates’ mysterious reaction to Fed policy   http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\video\statues-easter-island-small.jpg July 14 2021 July 14 2021

Explaining interest rates’ mysterious reaction to Fed policy  

Short-term rates more tied to monetary policy than long-term rates

Published July 14 2021
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Video Transcript
00:03
Hello, I'm RJ Gallo, Senior Portfolio Manager, Federated Hermes.
00:07
Why are long-term yields remaining so low, even as inflation is rising?
00:12
Well it's true that long-term yields have remained relatively low as inflation has clearly bubbled up during the reopening from the pandemic. I do think it's important to realize, however, that typically, short-term interest rates are much more tied to Fed policy than long-term interest rates are. It doesn't mean the Fed's policy doesn't matter at the long end of the curve, it clearly does. But as the Fed recently has signaled somewhat less dovishness, somewhat less accommodative approach to fiscal policy may emerge as we roll the calendar forward into next year, and the year thereafter, the fact that its short-term interest rates went up, made all the sense in the world. Long-term interest rates, however, some described as they were behaving in a mysterious ways. They actually went down after the Fed published its new Statement of Economic Projections. There's a couple of reasons for it. First, before the Fed meeting, which was in the middle of June, we've been seeing a lot of capital coming across the shores from Yen-based investors to Euro-based investors who could pick up significant yield by buying US treasuries even after hedging out foreign exchange risks as they're crossing borders with their money.
01:17
So there's been a strong underpinning of demand for US treasuries from abroad. Once the Fed somewhat surprised with their new Statement of Economic Projections, the dot-plot, there was another market factor that seemed to produce this somewhat surprising result. There were many investors, many institutional investors who were positioned for the yield curve to steepen as the Fed seemed likely to signal an ultra accommodative policy for far as you could think, and then inflation would just keep rising. Instead, the Fed sounded somewhat less accommodative and surprised the market a little bit. And that prompted a large rush to unwind curve-steeping trade. When you unwind a curve-steepening trade, you have to buy a long-term bonds and you can sell it as a short term bond. So long-term bond prices actually went up, yields down, and a surprising manner. That technical factor is probably going to come out in the wash. I think as we roll the calendar forward the fundamentals will take control of US interest rates across the treasury yield curve again, and we'll see treasury yields starting to behave in less surprising ways. So for example, we would expect treasury yields to rise as we move through into the end of this calendar year. We do think the yield curve at this point, its steepening trend is questionable and may actually start to flatten. And we think the 10 year treasury yield just to put a number to it, could probably end the year somewhere around 2% as the economy keeps reopening and the inflation story stays on the mind of investors.
02:44
Disclosure: Views are as of June 22, 2021, and are subject to change based on market conditions and other factors. This should not be construed as a recommendation for any specific security or sector. Investments are subject to risks and fluctuate in value. Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. Yield Curve is a 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. Federated Investment Management Corp. 21-10094 (7/21)
Tags Interest Rates . Markets/Economy . Monetary Policy .
DISCLOSURES

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.

Investments are subject to risks and fluctuate in value. There is no guarantee that any investment approach will be successful.

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

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.

Federated Investment Management Company