According to Bloomberg News, investors with fixed income think that the Fed will not tame inflation unless it makes progress with the recovery. With a noticeable decline in technology stocks and wild upheavals in the S&P 500, there has been considerable drama related to the equities in the current year. But if you want to get clues about where the US economy is heading, it is worthwhile to listen to the US Treasury market worth $23 trillion.
Higher inflation is a matter of concern
People buying Treasury securities are not worried about the returns from the government because the US government has always paid the bills. However, it is the inflation that they fear and worries about, which erodes the payments related to the future bonds.
Another aspect that makes the investors worried about is whether the US Federal Reserve intends to increase the short-term interest rates under its control. As investors anticipate higher inflation and hike in rates by the Fed to fight the same, they invariably demand higher compensation. As such, the bond prices are pushed down. Usually, yields rise when the prices fall. And the same is happening these days.
One of the greatest actions in the market is related to an increase in the 2-year US Treasury yields. There has been a doubling of the yields in the current year, from 0.7% to over 1.5%. The longer-term rates are escalating as well but less aggressively, with the ten-year Treasury yield rising above 2% in the current month for the first time since the beginning of the coronavirus lockdown.
Bloomberg News also reports that Congress and the Federal Reserve had to inject a lot of money into the economy due to the pandemic so that the businesses and the families could be supported. The supply chains have been under strain to meet consumer demands as the United States and other wealthier nations wriggle out of the emergency mode. There has been tightening in the labor market, and the lower interest rates have given rise to a boom in real estate that has pushed the rents and prices of homes upward.
Bloomberg News states that the price of bonds and derivatives trading shows that the market expects to foresee the Federal Reserve increasing the federal funds rate overnight at least 1.5% points in the current year. Many counterparts of the Federal Reserve points at similar instances.
The rebound of higher interest rates must resonate across the entire financial system, thereby impacting all types of workers, businesses, and borrowers. There is a subtle message of the bond market for the investors. In response to inflation, the Federal Reserve is walking on a fine line wherein it tries to tame inflation without hampering economic growth.
But the bond market is not sure whether the Federal Reserve will do the balancing act. The current scenario that yields for shorter terms and the ones for a longer term continue to be a low signal that the economy is cooling even in the years ahead. If the trend of higher yields for short terms and lower yields for longer terms continues, it will give rise to what is known as the inverted yield curve, which strongly signals that a recession is impending.
