The US bond market is sending a clear signal to the Federal Reserve as ongoing inflation risks could prevent premature monetary easing.
• Rising yields in the US bond market indicate growing inflation concerns
• Investors are once again pricing in possible interest rate hikes from the Fed
• Donald Trump is putting political pressure on the Fed
With the significant rise in yields on long-term US government bonds, the US bond market is sending a clear warning signal to the Federal Reserve to take inflation risks more seriously and not rule out possible further interest rate increases. The background is increasing doubts that the inflation fueled by the Iran war has been brought under lasting control. That’s why investors are now again pricing in scenarios in which the US Federal Reserve does not lower its key interest rates, but even raises them again.
Inflation remains stubborn
Recent developments in energy prices and raw materials have once again increased concerns about inflation. The markets are particularly concerned about the effects of geopolitical tensions and higher oil prices. At the same time, several Fed officials continue to see inflation risks. According to the financial portal MarketWatch, the markets are therefore increasingly doubting whether the current monetary policy stance is sufficiently restrictive.
Investors are following developments in long-term US government bonds particularly closely. The yield on the 30-year US government bond temporarily rose to its highest level since 2007. Rising yields are seen by the market as an expression of declining confidence that inflation will return to the Federal Reserve’s target level in a timely manner. In this context, the recent rise in yields reflects concerns that the US Federal Reserve may be considering monetary easing too soon, which is why investors are demanding a higher term premium for long-term securities.
Markets correct expectations of the Fed
At the beginning of the year, many investors were still expecting interest rate cuts. However, these expectations have now been significantly reduced. According to the data from the CME FedWatch tool, it can be seen that towards the end of the year, more and more market participants are even using a Interest rate increase calculate. There is also a more differentiated picture within the Federal Reserve’s Open Market Committee, as some central bank representatives have recently expressed noticeably more caution with regard to possible easing of monetary policy.
In addition, the US central bank is facing a historic change of power that will reshuffle the cards in the monetary policy structure. Tomorrow, Friday, Trump candidate Kevin Warsh, confirmed by the US Senate with 54 votes to 45, will be sworn in as the new Fed Chairman in the White House, replacing Jerome Powell. During his hearing before the Senate Banking Committee, Warsh vehemently emphasized to the senators in attendance that he was “not a puppet of President Donald Trump” and would act completely independently. Nevertheless, Kevin Warsh has already announced a far-reaching “regime change” that includes a redesign of the monetary policy framework to combat persistent inflation, changed communication and a forced unwinding of the central bank’s balance sheet through stricter quantitative tightening.
Donald Trump is pushing for low interest rates
In contrast, US President Donald Trump has repeatedly put pressure on the Federal Reserve and publicly called on the monetary authorities to loosen monetary policy more quickly. He argues that lower interest rates can make credit cheaper, stimulate the economy and thus support consumption, investment and stock market developments. In addition, falling financing costs would also make the high US national debt easier for the government to bear.
The current development on the bond market is increasingly in contrast to the demands from the White House. While the US President is pushing for interest rates to fall, many market participants continue to signal persistent inflation risks and believe additional interest rate increases are at least possible. The independence of the Federal Reserve will be put to a tough test under new boss Kevin Warsh as soon as he takes office.
Conclusion for investors
For investors, the macroeconomic environment is likely to become more volatile due to the upcoming change at the top of the Fed and the signals from the bond market. A prolonged high interest rate environment could put a structural strain on growth stocks in particular, while defensive sectors are likely to become more attractive in relative terms. Market participants should carefully analyze Kevin Warsh’s first official statements and the development of the core inflation rate in the coming weeks, as the future course of US monetary policy could be derived from this. Adjusting portfolio diversification towards shorter bond maturities and strong stocks could prove beneficial in this transition scenario.
Thomas Zoller, Alexandra Hesse, editorial team finanzen.net