The 10-year US Treasury bond yields are performing above the 2.5% level, to the highest level of the last three years. The underlying perspective of this move is the expectation that the Fed may tighten even more in monetary tightening, under the fight against inflation, and that rate hikes may be realized more sharply than the previously predicted path.
Powell's statements regarding the high inflation and its risks, combined with the emerging uncertainty, increase the probability that the Fed's next rate hike will be 50 basis points. The possibility of cost inflation created by commodities and energy creating a demand inflation that can actually be intervened by distorting consumer behavior causes Central banks to adopt a hard stance. Central banks want to keep inflation expectations under control and keep the phenomena outside the geopolitical risk effect on the desired path. However, even the current rate hikes keep real interest rates negative. It is feared that central banks will suffocate the dynamism and investment tendency in the economy by going too far in tightening in order to catch up with inflation. It is necessary to analyze the risks of the action potential of the Fed and a few other interest-raising central banks based on this phenomenon.
Fed OIS implied policy rate comparison chart… Source: Bloomberg
The most challenging factor in policy creation is that it is not known how long the war conditions will last and the economic effects of this cannot be fully revealed on the basis of coefficients. Due to the increase in the margin of error in policies, bond yield curves have reflected current phenomena to the movement of short-term interest rates, and the flattening of the yield curve has come to a point where it refers to historical recession signals.
The Fed is expected to pass this year with a total of 7 rate hikes and next year with 4 rate hikes. The probability of some rate hikes to be 50 basis points will mean that the Fed will move faster towards the terminal rate that it envisages in the long run. Seems like an aggressive enough trail. Guidance at the May meeting will be important here, as the market has now highlighted a nearly 50 basis point rate hike. It remains to understand whether it will accelerate the current path and how worried the Fed will be about capturing the inflation curve. The fact that real interest rates remain negative is a phenomenon that limits the effectiveness of rate hikes, which indicates that rate hikes and accordingly bond yields may go up.
The Fed funding rate projection is 1.9% for 2022, 2.8% for 2023 and 24, and 2.4% for the longer term. When we look at the Fed's inflation forecast, it is estimated that the PCE will be at the level of 4.3% in 2022. This forecast was 2.6% in the SEP published in the December FOMC. The Fed sees inflation almost twice as high as it did 3 months ago. Of course, this path will be in question if the current conditions continue, but if the war conditions due to the Ukraine - Russia crisis continues and if the supply problems cannot be resolved and deepened due to the conditions created by heavy sanctions, a higher path may also be in question. At this stage, even the fact that inflation is 4.5% at the end of the year may remain an optimistic forecast.
Kaynak: Tera Yatırım
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