Odds of Lower Fed Terminal Rate Rising in Slow-Inflation World
Alert: HALISTER1
Source: BFW (Bloomberg First Word)
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UUID: 7947283
(Bloomberg) -- Latest comments from Yellen and Brainard underscore the likelihood of a lower terminal rate for the current Fed tightening cycle and probably below the long-term dot-plot rate of 3%, keeping nominal yields in check over the medium term, Bloomberg strategist Tanvir Sandhu writes.
- Fed tightening into falling realized inflation is weighing on terminal rates with historically limited policy headroom for the next recession
- U.S. 2y1m -- a proxy for the Fed’s terminal rate - - has fallen this year to 1.86% along with breakeven rates, having required fiscal-policy expectations to play out to push neutral real rates (r*) away from zero
- A fall in inflation expectations lowers terminal rates via lower implied policy rates; with neutral real rate remaining sticky at 0%, Fed inflation target of 2% implies policy rate of 2% which gets pressured lower as inflation expectations fall
- Clearly, Fed knows financial conditions are too easy and wants some volatility to return but in turn would suppress inflation expectations, keeping nominal rates contained even as real rates rise
- Yellen signaled that the neutral rate of interest is very near the current fed funds rate, which is slightly dovish for the longer run outlook and increases the likelihood of a lower terminal rate for this tightening cycle
- This also cemented Brainard’s remarks a day before, which saw rates rally following the signal that there isn’t much more work to get to neutral rates with the neutral real fed funds likely to remain near zero
- Any significant rally in implieds and richening of payer skews in a rates selloff may be seen as an opportunity to fade, which also may be structured on a cross-market basis with Treasuries likely to outperform global core bonds
- Given the low levels of volatility and the binary economic outlook, three-month curve spread straddles may perform if either business-cycle pessimism deepens or outlook improves; risks are that vols continue to crush lower and rates remain stuck, see more here
- NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice
Alert: HALISTER1
Source: BFW (Bloomberg First Word)
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UUID: 7947283