The Fed Versus The Treasury Market – March 22, 2021

Fed Chair Powell attempted to calm escalating tensions in the Treasury market, to no avail. Bond investors are waking up to the danger that the Fed might actually succeed in its stated goal, with inflation finally moving higher after chronically coming up short in the last two decades.

A just-published report examined prospects for Fed policy in the next few years and concluded that bond investors will not be calmed by the persistence of its hyper-dovish rate path in the face of rising economic expectations. Moreover, our research highlighted that there are increasing odds of an upward tilt to core inflation, especially once the economy re-opens and recent sources of disinflation/deflation give way to a rebound. Input costs in many sectors are intensifying and the outlook is for little economic slack beyond the next few quarters, as economic growth will be turbo-charged by massive fiscal stimulus and pent-up demand.

We recommend maintaining inflation hedges, and staying bearish on bonds. The coming years will be a challenging time for the Fed if our rising inflation view pans out.


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