Inflation woes and a dovish Fed drive long rates up

In breve

Despite the latest strong economic rebound of the US economy and increasing worries about a surge in inflation, the Fed is tirelessly underlining that the conditions for withdrawing monetary support are still far from being met.
Focal Point

Highlights:

  • Markets price the first US rate hike as early as in H1 2023, mainly reflecting a higher risk premium on inflation fears. These
    worries are unlikely to ease in the short term given the volatility in inflation and employment.
  • In contrast, our estimate of the new Fed reaction function predicts a rate lift-off no earlier than in Q4 2023. Markets seem
    to have mixed views on the Fed’s stated higher tolerance towards inflation, requiring the Fed to improve its communication.
  • Expectations of an early liftoff strongly affect the short end of the curve. The currently priced strong increase in short-dated
    yields appears overdone. While not immune to the economic recovery and slowly approaching key rate hikes, short-dated
    US Treasuries are seen to hold up relatively well.
  • In contrast, long-dated US Treasuries remain vulnerable to a rise in real yields and a delayed lift-off. The USD yield curve
    is then set to steepen further.

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