Do rising yields mean faster policy tightening?

Thought of the day

by Chief Investment Office 01 Feb 2018

Bond yields are pushing higher. On 1 February, German 10-year yields traded at their highest level since late 2015 (0.73%) and US 10-year yields reached 2.75%, their highest since April 2014. The rise followed a slightly hawkish Federal Reserve statement and the odds of a March rate hike increased to 99% according to Bloomberg. Yields have been increasing partly due to rising inflation expectations: US 5-year breakeven rates have increased from an August low of 1.6% to 2%.

But, while rising bond yields can reflect anxiety over rising inflation and tighter monetary policy, so far there appears no cause for immediate concern:

  • Inflation was lower than expected for much of 2017 and remains below the Fed and European Central Bank targets of 2%. Recent data merely show a gradual creep toward the target. Core Eurozone CPI for January increased 0.1%, but only to 1%. US core PCE was unchanged at 1.5% in December, although the six-month annualized rate was firmer at 1.7%.
  • Central bank language doesn’t suggest faster tightening. On 31 January ECB member Benoit Coeure said “we have to be patient…because we’re not yet where we want to be in terms of inflation. The Fed statement changed only marginally, saying that conditions warrant “further gradual increases in federal funds rates,” with the word “further” added this time.
  • US 5-year breakeven inflation rates have increased, but at 2%, are no higher than the Fed’s target.

So we expect the removal of monetary stimulus to continue to proceed at a gradual pace. In our view, rising yields partly reflect market expectations adjusting after a period of lower than anticipated inflation.

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