| The consolidation in U.S. yields at the beginning of last week proved to be very short-lived, as the U.S. 10-year yield moved above 1.6% on the back of positive employment data and a lack of protest from the Federal Reserve. In response, the U.S. dollar index strengthened along with the dollar’s positive sensitivity to movement in yields. With Democrats committed to finalizing the $1.9 trillion stimulus package this week, upward pressure on yields should continue.|
As critical as the direction of yield movements is the speed at which yields move and the associated willingness and abilities of central banks to slow down moves in yields should they become disruptive to the global recovery. To this point, expectations remain for central banks to have the willingness and ability to step in and slow down, and even to push down rates, as realized inflation levels and unemployment rates remain far from stated target levels. This should then lead to a controlled rise in yields that remains supportive of global reflation and keep markets from experiencing sustained asset price volatility as well as helps explain why realized and implied foreign exchange volatility remains relatively low.
Thus far, both rhetoric and action out of some central banks have met expectations. Case in point, Australia experienced a sharp spike in rates, which led to the Reserve Bank of Australia (RBA) stepping in with 3 billion Australian dollars’ worth of bond purchases and following that up with another round of purchases at double its normal bond purchase rate. Subsequently, the RBA, at last week’s policy meeting, signaled to the markets that it would bring forward its current QE program and that it stands ready to go beyond the purchase amount already announced. Given this, it should be acknowledged that the RBA returned to normal-size purchases at the end of last week, but this came on the heels of a GDP beat and increased trade surplus that indicated conditions remained favorable.
Concerns around rising yields have also come out of the European Central Bank (ECB). Fabio Panetta, a member of the ECB’s executive board, has called the rise in euro area yields an “undesirable contagion from rising U.S. yields” and stated that the ECB shouldn’t hesitate to step up bond purchases if needed. This sentiment was echoed by ECB Vice-President Luis de Guindos and Bank of France Governor François Villeroy de Galhau.
Conversely, Fed officials have generally struck a positive tone on rising rates. This continued with Fed Chair Jay Powell declining to push back against either rate action or the market’s pull forward of Fed lift-off expectations last week. While Powell noted that recent market movements did catch his eye, he also indicated that he’s still comfortable with current conditions.
The Fed is clearly among the central banks most comfortable with the recent rise in yields because the U.S. economy is performing well, with another round of historically large fiscal stimulus that should keep conditions accommodative even with higher yields on the way. For what it’s worth, markets appear to believe that the Fed can keep things under control as the spread between five- and 10-year inflation breakevens is at its most positive level since this data series started in 2002. In essence, this is what the Fed’s flexible average inflation targeting (FAIT) framework is trying to achieve: a near-term inflation overshoot to make up for past undershoots followed by a return back down to target levels.
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