Bond Investors: Wishing They Had Ignored The Fed – September 19, 2022

A just-published report examined the perceptions and expectations in the Treasury market and at the Fed. It concluded that there is still considerable potential upside in bond yields and the fed funds rate on a cyclical basis.

The Fed was seduced by the persistence of low inflation last decade and significantly lowered its estimate of future inflation and the long-run policy rate. And despite the surge in growth and inflation in the past 2+ years, the Fed is still holding to a longer-term view of slightly less than 4% nominal growth ahead, which is far too low based on our research.

There is a huge gap between the FOMC’s long-run estimate of the fed funds rate and its (too low) economic growth rate, which highlights the ongoing longer-term vulnerability in the Treasury market. Long-term bond yields are still tethered to Fed guidance despite the latter being far offside in recent years. In parallel, other financial asset markets are also cyclically vulnerable.


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