Investors Bet Powell and Fed Will Be More Aggressive on Inflation

Investors are betting that the newly renamed Federal Reserve (Fed) chairman Jerome Powell will have to accelerate the pace of normalization of the central bank’s monetary policy to better cope with rising consumer prices.

For months, Powell has insisted that the current inflation outbreak is likely to be transitory, and has said that the central bank will “patientWhen deciding when to start raising your benchmark interest rate from near zero.

The Fed began reducing its $ 120 billion a month bond buying program in November, with a plan to end the purchases by mid-2022.

However, some investors believe that the Fed will have to reduce its program more quickly and raise rates earlier than expected to control the rise in consumer prices, which in October grew at the fastest pace in more than three decades.

His opinion has been reinforced by the recent public debate among some officials about the desirability of withdrawing support for the economy more quickly to help control inflation.

A barometer of investors’ monetary policy expectations, federal funds interest rate futures, had discounted on Monday afternoon a 100% chance that the central bank would raise rates in July, down from 92. % from last week.

News of Powell’s appointment on Monday also caused short-term Treasury yields, which are more sensitive to rate sentiment, to hit their highest level since early 2020.

Powell is widely seen as more of a hawk than Fed Governor Lael Brainard, who was also vying for the top job.

Investors are “defying the Fed to some extent and being more concerned about the Fed lagging behind on inflation”Said Mike Sewell, a portfolio manager at T. Rowe Price.

Sewell is buying short-term Treasuries and the US dollar, betting that the Fed will have to raise rates three times next year to control inflation.

The dot chart of the central bank’s forecast, released in September, showed that half of Fed members expected a rate hike next year.

Analysts at Jefferies wrote that Monday’s rise in Treasury yields, which move inversely to prices, “is based on the idea that the prospects for a rate hike in June 2022 have risen significantly after the Powell Repost ”, although the bank believes a hike is unlikely in June.

Bets on shorter-duration Treasuries have also attracted Gary Cloud, portfolio manager at the Hennessy Equity and Income Fund.

“We are in a time that investors have not seen before, because there is great uncertainty about whether the Fed will act in time.“To prevent inflation from skyrocketing, he said.

Diverging views on how aggressively the Fed will act have contributed to volatility in the Treasury markets. The ICE Bank of America MOVE index, which shows expectations for volatility in the bond market, is near its highest levels since April 2020.

Meanwhile, calls for the Fed to normalize monetary policy more aggressively are now coming from some of the central bank’s own officials, reinforcing the views of many investors.

Vice President Richard Clarida said earlier this month that “a debate on increasing the rate at which we are reducing our balance sheet”Would be something to consider at the next Fed meeting, while Governor Christopher Waller asked the Fed to double the reduction in bond purchases, ending in April 2022 to make way for a possible rate hike in the second trimester.

Powell, for his part, has said inflation is likely to decline as supply chain bottlenecks, which have contributed to higher prices, eventually subside.

There have been some signs that the worst of those outages are dissipating and shipping costs have dropped by a third in the last month. The prices of raw materials such as iron ore and wood also fell.

Others, however, insist that inflation continues to rise. Adam Abbas, portfolio manager and co-head of fixed income at Harris Associates, is buying bonds from companies like hotels, which could better deflect the effects of higher inflation by raising prices.

Donald Ellenberger, Senior Portfolio Manager at Federated Hermes, expects the volatility of the bond market to persist as inflation results “stickier”Than the Fed expected. It plans to focus on shorter-duration Treasuries until the 10-year note rises to 2.5% or more, a level it considers adequate given inflation.

“For many years the Treasury bond market was quite asleep and rates did not move much”, said. “Now the market does not know what to do in the face of the fact that inflation persists for longer than expected.”