The Fed finally unveiled its tapering program and it was globally in line with markets’ expectations. Jay Powell had the firm intention to emphasize that there is absolutely no link between tapering and any rate hike. As anticipated by the markets, the Fed will reduce its asset purchases by $15 billion / month (10 Treasuries + 5 MBS) but the devil is in the detail: all reinvestments of matured bonds will be exclusively done in Treasuries. This is good news for the long end of the US curve.
Jay Powell was also clear on the evolution of the labour market, saying “there is still ground to cover to reach maximum employment”. He explained that inflation should decrease gradually in Q2 or Q3 2022 and, as things stand, this is not a major issue that should modify the monetary policy, prompting a rate hike in the near future. He finally added that, should the economic environment change, the FOMC could consider a modification of the tapering.
The most important point is that the Fed is not considering any rate hike in the foreseeable future and the recent increase of short-end yields, pricing one or two rate hikes in 2022 after the end of the tapering was not relevant. It means that in the short term, the US Treasury curve could steepen slightly due to a rally of 2y-7y yields and a stabilisation of long-term yields of 10y-30y. In the medium term, we are convinced that the curve will flatten and 30y Treasuries are still the sweet spot.
In the markets, things are changing rapidly and the Fed’s decision is already almost obsolete. First and foremost because all eyes are now on the Non-Farm Payrolls data released today. After two very disappointing months in terms of job creations, the markets are awaiting impatiently this data; will job creations restart at a good pace, given that Jay Powell repeated that full employment is a major objective of the Fed.
More importantly, the FOMC of Wednesday is not THE key event of the week. It should have been but, against all odds, the BoE took the lead by making a decision that was totally unexpected. A rate hike was unanimously anticipated by the markets as inflation in the UK is increasing dangerously and because the mandate of the BoE is very clear on this topic. The BoE should have raised its key rate yesterday.
This rate hike has been postponed because the BoE believes that the current slowdown of the economic growth in the UK is a more important source of concern than a spike of inflation. A rate hike in this current environment would have been a monetary policy mistake. Everybody has been taken by surprise. The markets reacted aggressively: the cable (GBP-USD) firstly but also the bond markets, led by the Gilts (obviously) and the US Treasuries. The behaviour of the US yield curve yesterday was not driven by the FOMC but the BoE decision.
This is important in our view because we have been saying since the Jackson Hole meeting that markets pay too much attention to inflation and forget that growth is declining at the same time. We are convinced that inflation will decrease gradually, it will take longer than we thought initially but our major source of concern is a global slowdown (led by a probable recession in China). In this environment, any tightening of the monetary policy implemented by a central bank would be a mistake. For the first time, a central bank mentions and corroborates this view. The more surprising is that we could never imagine that this central bank would be the BoE.
As always, we invite investors and prospective investors, to contact us should they wish to understand our views on the current situation and the positions held in the portfolio. Please do not hesitate to contact us for further information.
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The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 05/11/2021 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.