The Fed sees higher bond yields and inflation expectations as a potential win

(Reuters) – The recent spike in US bond yields and market inflation expectations has boosted Fed officials’ hopes that the central bank’s new monetary policy approach will cement and could pick up if Congress, led by Democrats, begins to ramp up spending.

“I am encouraged to see market indices rising to inflation expectations. That is what we are trying to support, ”Federal President Thomas Barkin said Thursday in an interview with Reuters.

Barkin said he viewed the recent hike in Treasury interest rates as part of the “deflation trade,” an indication that investors were taking into account future price increases in their decisions by demanding higher interest rates, rather than representing a worrying tightening of finances. Circumstances.

“The components of high inflation are there,” James Bullard, president of the Federal Reserve Bank of St. Louis, told reporters in separate remarks. “You have a very strong fiscal policy in place and maybe more to come” with the Democrats now on the verge of taking control of the White House as well as the US Senate and House of Representatives.

“You have the Fed … want inflation to be temporarily above target. Pollard said the economy is set to thrive at the end of the pandemic,” as soon as the impact of the new coronavirus vaccines is felt.

The yield on the benchmark 10-year Treasury note rose above 1.07% on Thursday, its highest level since March. The five-year forward inflation forecast hit a nearly two-year high of 2.05%.

‘Incredibly frustrating’

After nearly two years of study, the Fed in August changed its approach to monetary policy to allow higher inflation, hoping to achieve its 2% target on an average basis by letting prices drift higher for some time in order to offset the years that are Where inflation was weak.

This would also allow, in theory, the unemployment rate to drop because the central bank would try to maintain the kind of “hot” economy that would drive up prices.

The tremendous uncertainty about the economy and the course of the pandemic late last summer gave way to what Barkin said was more “clear” about the current situation – with two coronavirus vaccines being distributed, condoms put in place to help many American families, and consumers are “not far” from the point where “They enter the economy with more confidence.”

The pace of vaccine deployment will play a big role at a time when this happens, as some policymakers have expressed dissatisfaction with the efforts to date.

Philadelphia Fed President Patrick Harker described early US vaccination numbers, with fewer than 5 million vaccines so far, “incredibly disappointing”.

However, the events of the past few weeks seem to have changed the market’s bets about the future, as trading in inflation-related securities indicates that investors are anticipating higher inflation and accepting that the Fed will not stand in its way.

“We are looking forward to a long period in which the federal funds rate will remain essentially zero,” Harker said, referring to the central bank’s overnight principal rate. He added that he saw no signs that “inflation will get out of control.”

Indeed, Chicago Fed Chairman Charles Evans has expressed greater doubts about upcoming inflation, even as additional government stimulus may be on the way to help fight the economic fallout from the epidemic and the recession it has wrought.

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

Mary Daly, chair of the San Francisco Federal Reserve, said at an event held Thursday by the Manhattan Institute’s Shadow Open Market Committee that she believes a stronger labor market will ultimately lead to higher inflation, despite the upward push of prices from the tight labor market. Likely. Weaker than in the past, making a sudden boom unlikely.

This means, as I suggested, the Fed could allow the labor market to strengthen even more than it has been in the past.

Meanwhile, Dali said she was reassured by the recovery of inflation expectations, which showed that market participants, households and corporations began to believe that the Fed would achieve its target of surpassing the 2% inflation rate.