Chart of the Month | Fed Remains Patient on Rate Hikes Despite Market Expectations For A More Aggressive Move

November 5, 2021 |
2 minute read
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In its latest meeting on November 3rd, the Fed announced its decision to begin scaling back its historic bond purchasing program, marking the beginning of the end of the program that was aimed at protecting the economy from the impact of the COVID-19 pandemic. While the Fed is expected to wrap up the process by mid-2022, Fed Chair Jerome Powell also said that the tapering does not imply hawkish moves regarding interest rates, remaining patient until further progress is achieved in the labor market. Investors began to price in a much more aggressive path towards normalized interest rates at the end of October. The front end of the Treasury curve was pricing in more than two 25 bp hikes by the end of 2022, causing the yield curve to flatten between the 2-year and 10-year tenors and invert between the 20/30-year tenors. In this chart of the month, we show the unusual move in the yield spread between the 2-year and 10-year notes which tightened by 13 basis points on October 27th. The flattening move is larger than 99.2 percent of all daily changes in the last 20 years as the 2-year yield moved higher due expectations of early Fed tightening. While short yields moved way ahead of the Fed guidance, poor market depth likely also aided the move. Conversely, 10-year yields moved lower due to expectations of a lower Fed terminal rate as economic growth could slow with a more hawkish Fed.

Stubbornly high inflation continued to drive market participants’ bets on hawkish Central Bank moves and higher interest rates. On October 29th, the Bureau of Economic Analysis (BEA) showed that consumer prices as measured by the PCE Deflator rose the most year-over-year since 1990, while the Bureau of Labor Statistics reported that its Employment Cost index rose the most since 2004. Price increases more than offset the earnings boost that workers received over the last 12 months. On October 28th, the BEA reported that U.S. GDP grew by 2.0 percent on an annualized basis in the third quarter which was weaker than the most bearish market expectations. A drop in consumption and inventory growth accounted for most of the disappointing report. However, despite the growth slowdown, investor positioning remained tilted towards higher interest rates.

Central Banks in other developed areas are dealing with similar market behavior, including Europe, the U.K., Canada and Australia. In Europe, the ECB president Christine Lagarde pushed back against expectations that the Bank will raise rates next year. However, investors found her message too weak and added to their bearish fixed income positions. Yields on Australia’s 3-year bonds recorded the biggest monthly increase since 1994 after the Reserve Bank of Australia stopped defending its yield target. In Canada, the BOC surprised markets by ending its bond-buying program and accelerated the timing for future rate increases. In the U.K., speculations that the BOE will be the first major Central Bank to hike rates also intensified in recent weeks.

At Commonfund, we believe in diversifying our fixed income portfolios and generating excess returns from subsectors such as leveraged loans and private credit. Those areas provide both a significant yield advantage and a shorter duration, which could be beneficial in a rising interest rate environment.

img-chart-of-the-month-2021-11

 
Ivo C. Nenin

Author

Ivo C. Nenin

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.